CareDx, Inc. - Annual Report: 2018 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

For the fiscal year ended December 31, 2018

OR

For the transition period from               to              

Commission File Number 001-36536

CAREDX, INC.

(Exact Name of Registrant as Specified in its Charter)

3260 Bayshore Boulevard

Brisbane, California 94005

(Address of Principal Executive Offices, Including Zip Code)

(415) 287-2300

(Registrant’s Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

Securities Registered Pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ☐    No  ☒

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the closing price of a share of the registrant’s common stock on June 30, 2018 as reported by the Nasdaq Global Market on such date was approximately $321,787,874. Shares of the registrant’s common stock held by each executive officer, director and holder of 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.

The number of shares of the registrant’s Common Stock outstanding as of March 4, 2019 was 41,728,442.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement relating to the 2019 Annual Meeting of Stockholders, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. Such Proxy Statement, or an amendment to this Annual Report on Form 10-K, will be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year ended December 31, 2018.

TABLE OF CONTENTS

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this Annual Report on Form 10-K other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” and the negative and plural forms of these words and similar expressions are intended to identify forward-looking statements.

These forward-looking statements may include, but are not limited to, statements concerning the following:

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These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section entitled “Risk Factors” included in Part I, Item 1A and elsewhere in this Annual Report on Form 10-K.  Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time.  It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make.  In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur.  Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements.  Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.

You should read this Annual Report on Form 10-K and the documents that we reference in this Annual Report on Form 10-K and have filed with the Securities and Exchange Commission, or SEC, as exhibits to this Annual Report on Form 10-K with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.  We qualify all forward-looking statements by these cautionary statements.

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PART I

ITEM 1. BUSINESS

Company Overview

CareDx, Inc. (“CareDx” or the “Company” or “we” or “us” and “our”) together with our subsidiaries, is a global transplant diagnostics company with product offerings along the pre- and post-transplant continuum.  We focus on discovery, development and commercialization of clinically differentiated, high-value diagnostic solutions for transplant patients.  In diagnostic testing services, we offers AlloMap, which is a gene expression solution for heart transplant patients and AlloSure, which is a donor-derived cell-free DNA (“dd-cfDNA”) solution initially commercialized for kidney transplant patients.  We also offer high quality products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs.

Testing Services

AlloMap

Our first commercialized testing solution, the AlloMap heart transplant molecular test, or AlloMap, is a gene expression test that helps clinicians monitor and identify heart transplant recipients with stable graft function who have a low probability of moderate-to-severe acute cellular rejection.  Since 2008, we have sought to expand the adoption and utilization of our AlloMap solution through ongoing studies to substantiate the clinical utility and actionability of AlloMap, secure positive reimbursement decisions for AlloMap from large private and public payers, develop and enhance our relationships with key members of the transplant community, including opinion leaders at major transplant centers, and explore opportunities and technologies for the development of additional solutions for post-transplant surveillance.  We believe the use of AlloMap, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a heart transplant.  In particular, we believe AlloMap can improve patient care by helping healthcare providers avoid the use of unnecessary, invasive surveillance biopsies and determine the appropriate dosage levels of immunosuppressants.  AlloMap has received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, for marketing and sale as a test to aid in the identification of recipients with a low probability of moderate or severe acute cellular rejection.

AlloMap has been a covered service for Medicare beneficiaries since January 1, 2006.  The 2018 reimbursement rate for AlloMap was $3,240, which represents a 14% increase over the 2017 reimbursement rate. AlloMap has also received positive coverage decisions from many of the largest U.S. private payers, including Aetna, Anthem, Cigna, Health Care Services Corporation (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE, and UnitedHealthcare.

We have also successfully completed a number of landmark clinical trials in the transplant field demonstrating the clinical utility of AlloMap for surveillance of heart transplant recipients.  We initially established the analytical and clinical validity of AlloMap on the basis of our Cardiac Transplanted Organ Rejection Gene Expression Observational (Deng, M. et al., Am J Transplantation 2006), or CARGO, study, which was published in the American Journal of Transplantation.  A subsequent clinical utility trial, Invasive Monitoring Attenuation through Gene Expression (Pham MX et al., N. Eng. J. Med., 2010), or IMAGE, published in The New England Journal of Medicine, demonstrated that clinical outcomes in recipients managed with AlloMap surveillance were equivalent to outcomes in recipients managed with biopsies.  The results of our clinical trials have also been presented at major medical society congresses and published in peer-reviewed publications in leading medical journals.

Since the launch of AlloMap in January 2005, we have performed more than 123,000 commercial AlloMap tests, including 16,116 tests during 2018, from our Brisbane, California, laboratory. We estimate that there are approximately 138 centers performing heart transplants in the United States. In 2018, 133 of these centers used AlloMap.

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AlloSure

AlloSure, our surveillance solution for kidney transplant recipients, applies proprietary next generation sequencing technology to measure dd-cfDNA in the blood stream emanating from the donor organ.  We believe AlloSure may help clinicians determine rejection-specific activity manifested as cell damage in the transplanted organ.  We also believe the use of AlloSure, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a kidney transplant.  In particular, we believe AlloSure can improve patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants.  Effective October 9, 2017, AlloSure became available for commercial testing with Medicare coverage and reimbursement.  The Medicare reimbursement rate for AlloSure is $2,841.  AlloSure has also received payment from private payers on a case-by-case basis, while our Payer Relations team works to establish positive coverage. However, no positive coverage decisions have been made to the date of this filing.

Prior to the commercialization of AlloSure, we generated a strong body of clinical evidence.  In late 2015, we announced the completion of analytical validation of AlloSure.  Samples used in the analytical validation included donor recipient pairs with unrelated donors, as well as closely related family members.  A report describing the analytical validation of AlloSure including clinical validation information for heart transplant, appeared in the November 2016 issue of The Journal of Molecular Diagnostics.  The Circulating Donor-Derived Cell-Free DNA in Blood for Diagnosing Acute Rejection in Kidney Transplant Recipients, or DART, trial, sponsored by us, was conducted between April 2015 and January 2018. DART was a 14 center observational study of kidney transplant recipients where blood specimens were drawn periodically after transplant during follow up visits and also after treatment for acute rejection. By the time of completion of the first analysis, 384 patients were followed in DART for up to 24 months. The results demonstrated that increased levels of dd-cfDNA, determined by the AlloSure assay, discriminated active rejection of a kidney transplant more effectively than serum creatinine values. In collaboration with clinical investigators, we published these findings in the scientific peer-reviewed Journal of the American Society of Nephrology and the Journal Applied Laboratory Medicine in March 2017. A total of 2,109 patient visits had been accrued in DART by January 2018. We plan to analyze and report on additional findings from this dataset in 2019 and into the future.

In January 2018, we initiated the Kidney Allograft Outcomes AlloSure Registry study, or K-OAR, to develop further data on the clinical utility of AlloSure for surveillance of kidney transplant recipients. As of December 31, 2018, 47 centers had been initiated as K-OAR sites and 748 patients had been enrolled.

Throughout 2018, there were 11,634 AlloSure patient test results provided from our Brisbane, California, laboratory. In the fourth quarter of 2018, AlloSure was ordered by 100 kidney transplant centers in the United States.

HeartCare

In September, 2018, we initiated the Surveillance HeartCare® Outcomes Registry (“SHORE”). SHORE is a prospective, multi-center, observational, registry of patients receiving HeartCare for surveillance.

HeartCare combines the gene expression profiling technology of AlloMap with the dd-cfDNA analysis of AlloSure-Heart® in one surveillance solution. An approach to surveillance using HeartCare provides information from the two complementary measures: (i) AlloMap – a measure of immune activation, and (ii) AlloSure-Heart – a measure of graft injury. HeartCare provides complementary information about distinct biological processes, such as immune quiescence, active injury, Acute Cellular Rejection (“ACR”) and Antibody Mediated Rejection (“AMR”) in heart transplant recipients.

Products

We develop, manufacture, market and sell products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs. Olerup SSP is used to type Human Leukocyte Antigen, or HLA alleles based on sequence-specific primer, or SSP, technology.  Olerup SBT is a complete product range for sequence-based typing of HLA alleles. QTYPE enables speed and precision in HLA typing at a low to intermediate resolution for samples that require a fast turn-around time and uses real-time polymerase chain reaction or, or PCR, methodology.  QTYPE received CE mark certification on April 10, 2018.

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On May 4, 2018, we entered into the License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina’s next generation sequencing product line for use in transplantation diagnostic testing.

As a result, on June 1, 2018, we became the exclusive worldwide distributor of Illumina’s TruSight HLA product line. In addition, we were granted the exclusive right to develop and commercialize other NGS product lines for use in the field of bone marrow and solid organ transplantation diagnostic testing.

Our History

We were originally incorporated in Delaware in December 1998 under the name Hippocratic Engineering, Inc.  In April 1999, we changed our name to BioCardia, Inc., and in June 2002, we changed our name to Expression Diagnostics, Inc.  In July 2007, we changed our name to XDx, Inc. and in March 2014, we most recently changed our name to CareDx, Inc.  Our principal executive offices are located at 3260 Bayshore Boulevard, Brisbane, California and our telephone number is (415) 287-2300.

On June 10, 2014, we acquired ImmuMetrix, Inc., or IMX, a privately held development-stage company focused on dd-cfDNA-based solutions in transplantation and other fields.  Through this acquisition, we added to our existing know-how, expertise and intellectual property in applying dd-cfDNA technology to the surveillance of transplant recipients, which has contributed to the development of AlloSure.  The intellectual property rights of IMX included an exclusive license from Board of Trustees of the Leland Stanford Junior University, or Stanford, to a patent relating to the diagnosis of rejection in organ transplant recipients using dd-cfDNA.

On April 14, 2016, we acquired 98.3% of the outstanding common stock of Allenex AB, or Allenex.  Our combination with Allenex created an international transplant diagnostics company with product offerings along the pre and post-transplant continuum.  As a result of the acquisition we now have a presence and direct distribution channels in the U.S. and Europe, with additional third party distributors in Europe and other markets around the world.  On March 15, 2018, we purchased the remaining 1.7% of outstanding common stock of Allenex.

On January 20, 2017, we acquired the business assets of Conexio Genomics Pty Ltd, Conexio, to offer a complete product range for sequence-based typing of HLA alleles.

On May 4, 2018, we entered into the License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina’s next generation sequencing, or NGS, product line for use in transplantation diagnostic testing.

As a result, on June 1, 2018, we became the exclusive worldwide distributor of Illumina’s TruSight HLA product line. In addition, we were granted the exclusive right to develop and commercialize other NGS product lines for use in the field of bone marrow and solid organ transplantation diagnostic testing.

As of December 31, 2018, substantially all of our revenues came from the United States and Europe, and substantially all of our assets and operations were located in the United States, Sweden and Australia.

We are organized and operate as a single reportable segment.  We changed our internal organization structure in the third quarter of 2018 and no longer operate in two reportable segments: Post-Transplant and Pre-Transplant.  Sales and other financial information by geographic area is provided in Note 16 of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Limitations of Existing Approaches for Surveillance of Transplant Recipients

The care of organ transplant recipients is an intense and costly effort and requires life-long surveillance and management by highly specialized clinicians and other healthcare providers.  The estimated U.S. average 2017 charges for a heart transplant is $1.38 million and for a kidney transplant is $0.41 million for the period 30 days before the transplant and 180 days after the transplant.  The lifetime cost for transplant recipients varies significantly depending on each individual patients circumstances.  Unsuccessful treatment of rejection can result in an additional transplant.  In

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the case of a kidney transplant, the median annual Medicare cost of care for a recipient whose kidney fails and is on dialysis is 500% more than the median annual cost of care for a recipient with a functioning transplant.  

The historical standard for heart transplant surveillance has been the microscopic examination of heart tissue obtained through an invasive endomyocardial biopsy.  In the biopsy procedure, a catheter is inserted into the right internal jugular vein in the recipient’s neck and threaded into the right ventricle of the heart.  Four pieces of tissue are cut from the wall of the heart and sent to the laboratory for examination by a pathologist who uses a microscope to look for evidence of cellular rejection.  Limitations of biopsies include: (i) the pathologist evaluations, which are subjective and dependent upon visual assessment and qualitative interpretation, (ii) tissue sampling errors, and (iii) the potential for procedure related complications such as damage to the valve structures in the heart.  The typical schedule of biopsy surveillance may involve eight to ten biopsies within the first six months after transplant and up to fifteen biopsies within the first year post-transplant.  Because repeated biopsies can cause cumulative risk and trauma to the heart, the frequency of biopsy surveillance after one year is low, despite the fact that recipients would benefit from continued monitoring for rejection and management of their immunosuppressive drugs for the rest of their lives.  With less biopsy data collected after the first year post-transplant, clinicians have less information upon which to tailor immunosuppression treatment for their recipients.

The use of renal biopsies for surveillance of kidney transplants is similarly limited due to the costs and risks associated with the invasive procedure.  Therefore, the main clinical test of transplanted kidney surveillance is serum creatinine levels.  An increase in serum creatinine levels is an indicator of diminished kidney function, and although this test is widely used, changes in serum creatinine are nonspecific as to cause and not sensitive, as serum creatinine may only be detected after significant and irreversible renal function loss has occurred.

The prevention and treatment of rejection in heart and kidney transplant recipients is managed primarily through the use of immunosuppressive drugs.  Surveillance biopsies are infrequent after the first year because of procedural risks, discomfort, inconvenience, expense and the low rate of finding silent rejection.  As a result, clinicians have limited and infrequent information about an individual recipient’s risk of rejection over the months and years following transplant.  In the average recipient, the immune system gradually adapts to the organ graft, and the need for immunosuppression declines over time.  However, there is meaningful variation in the level of rejection activity and need for immunosuppression among transplant recipients.  Limited insight into the immune status of the individual recipient often causes clinicians to adopt a “one-size-fits all” approach to immunosuppression to help protect against the severe consequences of rejection.  Although typical doses of immunosuppressants result in a low rate of rejection in the transplant population as a whole, many individuals may receive more intense immunosuppressants than they actually need.  

The Need for a Better Surveillance Solution

Improved post-transplant diagnostics are necessary to achieve further gains in the long-term care and health outcomes of heart, kidney and other organ transplant recipients.  More effective solutions for the surveillance and risk assessment of recipients would improve the clinician’s ability to individualize immunosuppression therapy and to reduce the use of invasive biopsies.  We believe that core elements of effective surveillance solutions include:

Our Services and Products

Testing Services

We develop and provide a diagnostic surveillance testing service for heart and kidney transplant recipients.  

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Our first commercialized testing solution, AlloMap, is a gene expression test that helps clinicians monitor and identify heart transplant recipients with stable graft function who have a low probability of moderate-to-severe acute cellular rejection. AlloMap is designed to help health care providers and their patients to better manage long-term care, avoid the use of invasive surveillance biopsies and determine the appropriate dosage levels of immumosuppressant medications.  AlloMap uses a sample of the patient’s blood.  AlloMap may be used instead of a surveillance heart biopsy to rule out acute cellular rejection in heart transplant recipients.  AlloMap offers rapid, high quality results, and we aim to return AlloMap results to the clinician within three business days after the blood draw.

The test measures the molecular signatures that correlate with biological activity associated with moderate to severe acute cellular rejection. Gene expression may indicate acute cellular rejection well before the evidence of damage is visible from a tissue biopsy sample.  AlloMap applies a proprietary mathematical algorithm comprised of the expression of 20 genes, as measured by specific RNA levels.  Of the 20 genes, 11 are informative and 9 are for quality control.  The algorithm then yields a single AlloMap score.  AlloMap may be used for heart transplant recipients 15 years of age or older, starting on day 55 post-transplant.

AlloMap provides a single integer score ranging from 0 to 40 and determines the probability of the absence of moderate to severe acute cellular rejection.  A key benefit of the AlloMap score is its negative predictive value, or NPV.  The NPV of AlloMap is the likelihood that a heart transplant recipient does not have acute rejection.  The NPV for recipients with an AlloMap score below the threshold value can be greater than 99% depending on the actual score.

The clinical utility of AlloMap is well established.  AlloMap is the first and only non-invasive method recommended in the International Society for Heart & Lung Transplantation, or ISHLT, patient care guidelines for surveillance of heart transplant recipients for rejection in non-infants.  AlloMap has obtained 510(k) clearance from the FDA as an In Vitro Diagnostic Multivariate Index Assay, or IVDMIA.  In addition, the clinical utility of AlloMap is supported by numerous clinical trials that we have sponsored, the results of which have been published in leading peer-reviewed medical journals.

When incorporating AlloMap into their practice, clinicians may consider recipient history, a physical exam, graft function and the results of AlloMap at each post-transplant clinic visit.  If the recipient’s AlloMap score is below an applicable threshold, in the absence of other clinical indicators of rejection, clinicians may elect not to conduct a surveillance biopsy at that time.  Where there are signs or indications of rejection, evidence of failure or impaired function or an AlloMap score greater than the applicable threshold, a biopsy may be ordered.

AlloMap Score Variability, or AMV, is a service we offer that we believe provides useful, complementary information to help personalize long-term care of heart transplant recipients.  It is available only upon request by clinicians.  A patient’s AMV is based on the variability of a patient’s AlloMap scores over time and may be used as a risk stratification tool in estimating the probability that one or more of the clinical events in heart transplant recipients may occur in the future.  AMV may be computed from four AlloMap test results within a 24-month period.  A low AMV may indicate a lower risk of future events, which suggests that a patient may be a potential candidate for reduced immunosuppression.  A high AMV may indicate a higher risk of future events, which suggests a patient may merit more vigilant surveillance.  The concept of AMV was developed over the course of several years, beginning as an observation in clinical studies of low score variability among stable patients which suggested that AMV might be a predictor of future clinical events and rejection episodes.  The Cardiac Allograft Rejection Gene Expression Observational II, or CARGO II, study included data which demonstrated that AMV may be useful in estimating the probability of future adverse events, such as death, re-transplantation or graft failure in heart transplant recipients who were undergoing surveillance with AlloMap testing more than 315 days following transplantation.

AlloSure, our surveillance solution for kidney transplant recipients, applies proprietary next generation sequencing technology to measure dd-cfDNA in the blood stream emanating from the donor organ.  We believe AlloSure may help clinicians determine rejection-specific activity manifested as cell damage in the transplanted organ.  We also believe the use of AlloSure, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a kidney transplant.  In particular, we believe AlloSure can improve

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patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants.

HeartCare combines the gene expression profiling technology of AlloMap with the dd-cfDNA analysis of AlloSure-Heart in one surveillance solution. An approach to surveillance using HeartCare provides information from the two complementary measures: (i) AlloMap – a measure of immune activity, and (ii) AlloSure-Heart – measures graft injury. HeartCare provides complementary information about distinct biological processes, such as immune quiescence, active injury, Acute Cellular Rejection (“ACR”) and Antibody Mediated Rejection (“AMR”) in heart transplant recipients.

Clinical Trials of AlloMap and AlloSure

The clinical validation and utility of AlloMap is supported by a number of major clinical trials involving more than 2,000 heart transplant recipients and published in leading peer-reviewed medical journals.  Our trials are designed to evaluate the clinical utility of our solutions and are an integral part of our business strategy, clinical development and marketing programs.  In heart transplantation, two major observational trials, CARGO and CARGO II, enabled the initial development, validation and further validation of AlloMap to detect and monitor acute cellular rejection in heart transplant recipients.  In addition to preserving blood samples and clinical data from these two trials, we have sponsored a multi-year, 34 multicenter-registry named OAR, which focuses on long-term outcomes of patients.  We expect these samples and data to enable further discovery and product development of new biomarkers of organ rejection activity, and new diagnostic solutions.  These repositories contain over 37,000 samples obtained from individual recipients who were typically followed for 10 serial visits and over one year or more, and who in many cases have associated biopsy-based rejection grades and other clinical outcome endpoints.  We believe this extensive biorepository and database will be useful for new product development derived from analyses, correlative studies and validation efforts.

Additional clinical utility trials, including IMAGE and the Early Invasive Monitoring Attenuation through Gene Expression, or EIMAGE, have demonstrated that clinical outcomes in recipients managed with AlloMap surveillance were equivalent to outcomes in recipients managed with biopsies. We have also published two reports of retrospective analyses from IMAGE and CARGO II trials that demonstrate that the variability in AlloMap scores over time in an individual patient may be useful in predicting the risk for the patient of a future event of rejection and graft dysfunction.

In March 2017, the Journal of the American Society of Nephrology published the article Cell-Free DNA and Active Rejection in Kidney Allografts.  The article reports that increased levels of dd-cfDNA detected using AlloSure are associated with active rejection of the kidney allograft.  The DART study evidence suggests that AlloSure, a non-invasive blood test, may enable more frequent, quantitative, and safer assessment of allograft rejection and injury. As part of a surveillance strategy, AlloSure could help identify patients with new or ongoing organ injury.  In the DART study, to investigate the use of AlloSure as a surveillance tool, the investigators prospectively collected blood specimens from renal transplant patients at scheduled intervals and at the time of clinically indicated biopsies. Key findings of the study were as follows:

This was the first report to establish clinical performance characteristics for dd-cfDNA in renal transplant patients with an analytically validated assay of dd-cfDNA in the largest (N =398 patients) prospective, multicenter observational study of dd-cfDNA.  Elevations in AlloSure were found to be strongly correlated with active rejection, especially ABMR. ABMR is increasingly recognized as the form of immune-mediated injury causing long-term

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graft loss.  This progress was made possible by collaboration with 14 major renal transplant centers and their patients who volunteered to participate in the study.

A publication in the Journal of Applied Laboratory Medicine in March 2017 described the biological variation and clinical reference intervals of dd-cfDNA in stable healthy renal transplant recipients.

The AlloSure test has been approved for Medicare coverage for clinical use when a physician determines there is a need to assess the probability of allograft rejection in kidney transplant recipients.  The DART study suggests that AlloSure can be used to discriminate the probability of active rejection from absence of rejection in a renal transplant recipient.  Use of the test may reduce invasive percutaneous renal biopsy procedures among patients with a suspicion of rejection.

Publications based on the analyses of the accumulated DART database results were used as a guide to design K-OAR.  K-OAR is a multicenter, non-blinded, prospective observational cohort study which plans to enroll greater than 1,000 renal transplant patients who will receive AlloSure long-term surveillance. The clinical outcomes of these patients will be entered into a registry database. The study cohort will include 300 patients at centers that will obtain planned renal surveillance biopsies at 12 months post-transplantation.  The other greater than 700 patients will be from centers that do not perform protocol surveillance biopsies. Outcomes in this greater than 700 patient sub-cohort, which represents the majority of the intended use population in the U.S., will be compared to the outcomes of the 300 AlloSure tests from the 12 month surveillance biopsy centers.

A matched control cohort of 300 patients will be retrospectively selected from the subset of centers providing the test cohort patients who have planned surveillance biopsies at 12 months post-transplantation.  The primary safety endpoint of this study is the amount of kidney tissue scarring and atrophy at one-year post-transplant, quantified by biopsy-based histopathology grade(s). The primary efficacy endpoint is the number of renal allograft biopsies performed during the first year.  Outcomes will include patient survival, graft survival, serum creatinine and estimated glomerular filtration rate, evaluated at years 1, 2 and 3 post-transplantation.

Products

We develop, manufacture, market and sell products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs.

Olerup SSP is used to type HLA alleles, based on SSP technology. Olerup SBT is a complete product range for sequence-based typing of HLA alleles. QTYPE enables speed and precision in HLA typing at a low to intermediate resolution for samples that require a fast turn-around-time and uses real-time polymerase chain reaction, or PCR, methodology. TruSight HLA is high resolution solution that uses NGS methodology.

The Olerup SSP product line comprises products for low to high-resolution HLA typing. The product line includes close to 400 different typing products, covering the approximately 17,331 different HLA alleles (gene variants) that have been identified to date. New HLA alleles are identified frequently and the typing kits are routinely updated for new alleles. SCORE6, our custom developed software simplifies interpretation and documentation of laboratory results. We offer one of the most up-to-date and comprehensive libraries of HLA typing kits based on SSP technology.

Olerup SBT is a sequence-based typing product for HLA alleles that uses specifically designed software, Assign SBT, a sequence analysis software program that provides high resolution HLA typing.

QTYPE was commercially launched at the end of September 2016. QTYPE primarily focuses on low- to intermediate resolution typing where high-resolution typing is not a requirement but even more rapid typing results are required, such as for deceased donor typing.  When transplanting organs from deceased donors it is of great importance to be able to expediently carry out HLA typing to find an appropriate recipient. Typing with QTYPE requires approximately one hour compared to the up to 2-3 hours that it takes to do traditional SSP typing and the 5-7 hours that it takes with sequence-specific oligonucleotides, or SSO. QTYPE comes with custom software,

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SCORE6.  QTYPE received CE mark certification on April 10, 2018.  QTYPE is validated on a broad range of instruments including the Roche LightCycler® 480 II, QuantStudio 6, 7 and ViiA-7.

TruSight HLA is a NGS-based high resolution typing solution that provides NGS-level resolution to HLA typing.  CareDx licensed the exclusive world-wide distribution rights to this product from Illumina in May 2018.

Our suite of AlloSeq products are development-stage NGS-based kitted solutions that we acquired as a result of our May 2018 License Agreement with Illumina.  These products include: AlloSeq HLA, a high-resolution HLA typing solution, AlloSeq cfDNA, our surveillance solution designed to measure dd-cfDNA in blood to detect active rejection in transplant recipients, and AlloSeq BMT, a NGS solution for chimerism testing for stem cell transplant recipients.  Our AlloSeq products are designed to run on Illumina’s NGS instrumentation.  We intend to launch our AlloSeq products in 2019.

Research and Development

Our research and development activities focus on developing cutting edge organ transplant surveillance solutions, further expanding on our pre-transplant matching solutions and seeking to continuously explore and develop new clinically-relevant approaches to our products. Clinical operations dedicated to the design and implementation of high quality studies and registries for data collection to develop evidence to address unmet clinical needs of transplant recipients are included in research and development. Our ongoing efforts include:

Our research and development efforts are not limited to specific technology platforms, biomarkers or methodologies.  Instead, we aim to leverage current and future innovations in biomarker identification and measurement, study design and data integration in developing future solutions.

dd-cfDNA for Kidney Transplants

Our published DART clinical study has established the clinical validity of a dd-cfDNA-based solution for kidney transplant patients, AlloSure.  This is the first report to establish clinical performance characteristics for this emerging molecular biomarker in renal transplant patients with an analytically validated assay of dd-cfDNA in the

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largest (N =398 patients) prospective, multicenter observational study of dd-cfDNA.  The study population is representative of the spectrum renal transplant recipients in the United States. Elevations in AlloSure were found to be strongly correlated with active rejection, especially with ABMR. ABMR is increasingly recognized as the form of immune-mediated injury causing long-term graft loss.

K-OAR is the next step in the further development of data to support the clinical utility of AlloSure.  The Centers for Medicare & Medicaid Services (“CMS”), Medicare Administrative Contractor (MAC), Palmetto GBA (Palmetto”), in October 2017, recommended Medicare coverage for AlloSure which is contingent on this further data development.  The K-OAR study commenced in January 2018. K-OAR is a 1, 2 and 3 year post-transplant clinical outcomes study in patients managed with AlloSure surveillance compared to another 300 patients who will serve as a comparative control group managed without AlloSure.

dd-cfDNA for Heart Transplants

We believe that the AlloSure dd-cfDNA-based solution could provide additional value to AlloMap testing for clinicians caring for heart transplant patients, particularly in situations where a recipient’s AlloMap score suggests a probability of acute rejection.

Studies have reported that a higher percentage of dd-cfDNA in the blood stream of patients is found with moderate or severe heart rejection compared to patients without rejection. We believe a dd-cfDNA solution such as AlloSure for the heart could help clinicians identify recipients with a higher probability of rejection and help determine which patients warrant a subsequent biopsy, because the likelihood of detecting rejection in the biopsy specimen would be enhanced.

Accordingly, we are offer HeartCare. HeartCare combines the gene expression profiling technology of AlloMap with the dd-cfDNA analysis of AlloSure-Heart in one surveillance solution. An approach to surveillance using HeartCare provides information from the two complementary measures: (i) AlloMap – a measure of immune activation, and (ii) AlloSure-Heart – measures graft injury. HeartCare provides complementary information about distinct biological processes, such as immune quiescence, active injury, Acute Cellular Rejection and Antibody Mediated Rejection in heart transplant recipients.

We have established our proprietary strategy for quantification of donor specific dd-cfDNA and we have completed initial proof of concept studies. We now offer AlloSure as a laboratory developed test for a limited number of heart transplant centers and physicians as part of our Utility of Donor-Derived Cell-Free DNA in Association with Gene-Expression profiling (AlloMap) in Heart Transplant Recipients, or D-OAR, study.

Product Advancement and Development

Ongoing research and development in the pre-transplant arena encompasses six areas. First, the last decade of next generation sequencing has unveiled significant additional sequence diversity in the HLA region on chromosome 6 of the human genome. While the clinical impact of some of the sequence diversity is unclear, many newly identified HLA alleles need to be integrated into ongoing updates of the Olerup SSP and QTYPE kits. We have been updating, and intend to continue to update, our HLA typing kits with newly identified alleles. Olerup SSP and QTYPE use technology platforms that can readily accommodate this increase in HLA allele assays.

Second, the advent of NGS technology has enabled significant improvement in HLA sequencing data.  We are developing further improved versions of NGS HLA testing that will provide full gene coverage while streamlining the laboratory workflow.

Third, our NGS testing platform will be a technology departure from commonly used approaches for HLA typing. This will enable the addition of non-HLA genes critical to transplant outcome. The addition of non-HLA genes will have no impact on workflow and enable the inclusion of increasing content, as new transplant outcome related genes are described.

Fourth, depending on the specific indication, different levels of HLA typing resolution and follow up confirmatory testing are required. Olerup SSP and QTYPE flexible platforms are complemented with Olerup SBT and TruSight

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HLA, and our research and development staff weave together the three typing product offerings to effectively address laboratory needs.

Fifth, the complexity of the HLA region benefits significantly from interpretive software solutions for the laboratories. We are committed to ongoing upgrades to our software solutions to further simplify the use of the various HLA kits.

Finally, our research and development staff in transplant environment is working closely together to advance the synergies of products across the pre- and post-transplant continuum.

Reimbursement

We have been successful in achieving reimbursement for our testing services.

Reimbursement for AlloMap comes primarily from Medicare, private third party payers such as insurance companies and managed care organizations, Medicaid and hospitals.  A number of payers have adopted coverage policies approving AlloMap for reimbursement.  Such policies often approve reimbursement for tests performed from six months or one year post-transplant through five years post-transplant.  For tests performed outside the scope of the payer’s policy, and for tests performed where the payer has not adopted a coverage policy, we pursue reimbursement on a case-by-case basis.  If a reimbursement claim is denied, we generally pursue payment through the particular payer’s appeal process.

Following the assignment of a Category 1 Current Procedural Terminology, or CPT code, for AlloMap in September 2015, CMS, issued a proposed Clinical Laboratory Fee Schedule, or CLFS, Preliminary Determinations for calendar year 2016.  In October 2016, CMS reversed its preliminary gapfill determination for the 2017 CLFS and restored the final pricing determinations for AlloMap in the 2017 CLFS to $2,821.  The Protecting Access to Medicare Act of 2014, or PAMA, includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS would report initially and then on a subsequent three-year basis thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests.  CMS will use the rates and volumes reported by laboratories to develop Medicare payment rates for the tests equal to the volume-weighted median of the private payer payment rates for the tests. Effective January 1, 2018, Medicare reimburses $3,240 for AlloMap testing of Medicare beneficiaries, which represents a 14% increase over the 2017 reimbursement rate.  Effective October 9, 2017, AlloSure is reimbursed for kidney transplant patients covered by Medicare. The Medicare reimbursement rate for AlloSure is $2,841.

Medicare coverage and reimbursement was determined by the Molecular Diagnostic Services, or MolDX, Program developed by Palmetto GBA (“Palmetto”).  AlloSure began to be reimbursed at a rate of $2,841 for kidney transplants patients covered by Medicare across the United States on October 9, 2017, the effective date of the Palmetto local coverage determination, or LCD. AlloSure has also received payment from private payers on a case-by-case basis, while our Payer Relations team works to establish positive coverage. However, no positive coverage decisions have been made to the date of this filing.

Medicare

We are reimbursed by Medicare for AlloMap and AlloSure tests performed on patients covered by Medicare. Tests performed on patients covered by Medicare represented 46%, 30% and 34% of all tests in 2018, 2017 and 2016, respectively. Approximately 62%, 27% and 44% of all testing services revenue was derived from Medicare for the years ended December 31, 2018, 2017 and 2016, respectively.

Private Payers and Medicaid Payers

We are reimbursed for a substantial portion of the AlloMap tests we perform on patients covered by private payers. Coverage policies approving AlloMap for reimbursement have been adopted by many of the largest private payers, including Aetna, Anthem, Cigna, Health Care Services (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE, and UnitedHealthcare. Many other payers have positive coverage policies for AlloMap. With private

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payers and Medicaid payers that have not yet adopted positive coverage policies for AlloMap, we obtain reimbursement from those payers on a case-by-case basis for a significant portion of claims.

As of yet, no private payers or Medicaid payers have adopted positive coverage policies for AlloSure.  As a result, we obtain reimbursement from those payers on a case-by-case basis.

International

Our products have a broad international presence.  We sell directly to customers in many regions and also sell through third-party distributors and sub-distributors throughout Europe and the rest of the world.

In 2013, we initiated a commercial agreement with Diaxonhit SA (“Diaxonit”), a leader in specialty in-vitro diagnostics for transplantation, infectious diseases and cancer. The agreement carries a 10-year term and grants Diaxonhit exclusive rights to promote AlloMap in Europe. Diaxonhit has agreed to commercialize AlloMap in all countries in western and central Europe directly and through sub-partners. Under the terms of our agreement, we provide Diaxonhit with training and a license to perform AlloMap. In Europe, we receive revenue in two ways: first, through our sale of testing materials to Diaxonhit, and second, through royalties on Diaxonhit’s net earnings from sales of AlloMap. Diaxonhit pays royalties to us as a percentage of the net earnings from sales, as defined in the agreement, of AlloMap tests, in the mid to high teens. Diaxonhit made an upfront payment to us in cash of approximately €387,500 ($408,000) and Diaxonhit’s publicly traded common stock with a value at the time of €387,000 following execution of the agreement. Through Diaxonhit, we have also secured a dedicated laboratory, the Strasbourg University Hospital Central Immunology Laboratory, or HUS, in France.

Testing and Laboratory Operations

Our laboratory operations, where we perform all AlloMap and AlloSure testing, are headquartered at our Brisbane, California laboratory. Our laboratory holds a certificate of accreditation under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and is accredited by the College of American Pathologists (“CAP”).  We believe that our laboratory capacity will be adequate to meet demand for AlloMap and AlloSure for the next few years.

When a clinician orders AlloMap, a blood sample is drawn and processed to isolate the white blood cells, which are subsequently broken down, frozen and sent via overnight courier to our laboratory.  Each of the 20 genes comprising AlloMap is tested in triplicate, and the 11 informative genes are combined to produce the AlloMap score.  The remaining 9 genes are used as part of the rigorous quality control testing performed to assess every phase of the test process. The test results are reported to the ordering clinician by fax or electronically via WebPortal within two business days of receipt of the sample.  Test samples that fail to meet quality control criteria are immediately re-tested and the ordering clinician is notified of the need to re-test if turnaround time will be affected.

When AlloSure is ordered by a clinician, a blood sample is drawn and sent overnight at ambient temperature to our laboratory. Cell-free DNA is purified from the plasma and the fraction of the total cell-free DNA derived from the transplanted organ, the dd-cfDNA, is quantified and reported as a percentage. Tests that fail to meet quality control criteria are immediately re-tested and the ordering clinician is notified of the need to re-test if turnaround time will be affected.  Results are reported to the ordering clinician by fax or electronically within our WebPortal within two business days of receipt.

We rely solely on certain suppliers to provide some of the laboratory instruments and key reagents that we use to perform AlloMap and AlloSure testing. These sole source suppliers include Thermo Fisher Scientific, which supplies us with instruments, laboratory reagents, a master mix formula and consumables; Roche Molecular Systems, which supplies us with laboratory reagents and consumables; Illumina, which supplies us with instruments, laboratory reagents and consumables; Becton, Dickinson, and Streck, which supplies us with cell preparation tubes; Beckman Coulter, which provides laboratory reagents and consumables; and Qiagen N.V., which supplies us with a proprietary buffer reagent.

Manufacturing

We have historically purchased many of the components and raw materials used in our product kits from numerous suppliers worldwide. For reasons of quality assurance, sole source availability or cost effectiveness, certain

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components and critical raw materials used in the manufacture of our products are available only from one supplier. We have worked closely with our suppliers to develop alternate backup plans to assure continuity of supply while maintaining high quality and reliability, and in some cases, we have established long-term supply contracts with our suppliers. Due to the high standards and FDA requirements applicable to the manufacturing of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. In the event that we are unable to obtain sufficient quantities of raw materials or components on commercially reasonable terms or in a timely manner, our ability to manufacture our products on a timely and cost-competitive basis may be compromised, which may have a material adverse effect on our business, financial condition and results of operations.

Our manufacturing facility in Stockholm, Sweden is used to support the production, packaging and labeling of our proprietary test kits: Olerup SSP, XM-One, and QTYPE.  The facility has a certified Quality Management System, or QMS, to standards ISO 9001:2008 and ISO 13485: 2016.  These standards include a special set of requirements specifically related to the supply of medical devices and related services. ISO is an internationally recognized standard for QMSx.  Recertification is required every three years and we have been successfully recertified since obtaining our original ISO certification.  The facility maintains a valid EC certificate for compliance to Directive 98/79/EC Annex IV, excluding Sections 4 and 6, Full Quality Assurance System In Vitro Diagnostic Medical Devices. Annual surveillance audits are also conducted by the site’s notified body to ensure ongoing compliance.  Additionally, we seek to manufacture to current Good Manufacturing Practice requirements and our QMS is implemented in accordance with FDA Quality System Regulations.

Our manufacturing facility in Fremantle, Australia, is used to support the production, packaging and labeling of our proprietary Olerup SBT brand kits. The facility maintains a valid EC certificate for compliance to Directive 98/79/EC Annex IV, excluding Sections 4 and 6, Full Quality Assurance System In Vitro Diagnostic Medical Devices, and is certified to standards ISO 13485: 2016 and the Canadian Medical Devices Conformity Assessment System, or CMDCAS, for Medical Devices, undergoing the same certification and surveillance audit requirements.

Sales and Marketing

Testing Services Sales and Marketing Team

We have a direct field team in the United States that interacts with all aspects of the testing services channel, including sales, marketing, medical science liaison, managed care, and patient care management representatives.

Our marketing strategy focuses on the clinical benefits of AlloMap and AlloSure, and the scientific validation that supports our tests. Our strategy includes education to clinicians and the care team at transplant centers, assistance with scheduling ordered tests for patients, and working with centers to adopt formal protocols.

Product Sales and Marketing Team

The product business has sales offices in Vienna, Austria; Stockholm, Sweden; West Chester Pennsylvania, United States; and Fremantle, Australia, which manage direct sales to customers and sales through third-party distributors.  As of December 31, 2018, the sales and marketing team consisted of 20 employees, including sales, marketing, brand managers, and customer service representatives.

Competition

Because of our comprehensive portfolio of HLA typing products and surveillance diagnostic test services, we face many different types of competition. 

Testing Services

Our competition principally includes clinical reference labs and hospital labs using existing and routine clinical chemistry tests. We believe the principal competitive factors in our target markets include:

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We believe we compete favorably on the factors described above.

Existing diagnostic methods for heart transplant rejection generally involve evaluating biopsy samples to determine the presence or absence of rejection, while existing diagnostic methods for kidney transplant rejection include general, non-specific clinical chemistry tests, though biopsies are also a surveillance diagnostic tool. Both of these practices have been the standard of care in the United States for many years, and we will need to continue to educate clinicians, transplant recipients and payers about the various benefits of our tests in order to change clinical practice. Also, many transplant centers are located within hospitals that have their own laboratory facilities and have capacity to conduct various tests so hospitals may choose to rely on internally developed and/or internally performed surveillance and diagnostic tests.

We expect the competition for post-transplant surveillance to increase as there are several established and early-stage companies in the process of developing products and services for the transplant market that may directly or indirectly compete with AlloMap, AlloSure or our development pipeline. In addition, companies that have not historically focused on transplantation, but have knowledge of dd-cfDNA technology, have indicated they are considering this market.

Products

Our competitors within the HLA tissue typing markets comprise a diverse range of manufacturers servicing hospital and commercial reference testing laboratories.  The market leader in HLA typing and third party distributors is Thermo Fisher through its acquisition of transplant-focused companies One Lambda and Life Technologies. In certain HLA tissue typing markets that incorporate a wide variety of technology test platforms, such as SSP, SBT, SSO and NGS, competitors include Thermo Fisher, Omixon, GenDx and Immucor.  We also face competition from hospital and commercial reference labs that develop their own in-house testing solutions known in the diagnostics industry as “home brews”.  We believe that our product line competes favorably with Thermo Fisher as a leading supplier of HLA test kits based on performance, reputation and service.

We expect future competition for post-transplant surveillance kitted solutions as we launch AlloSeq cfDNA and AlloSeq BMT.  There are several established and early-stage companies in the process of developing products and services for the transplant market that may directly or indirectly compete with our development pipeline. In addition, companies that have not historically focused on transplantation, but have knowledge of dd-cfDNA technology, have indicated they are considering the transplantation market.

Overall Competition

Our potential competitors may have widespread brand recognition and substantially greater financial, technical and research and development resources and selling and marketing capabilities than we do.  Other competitors may develop products with prices lower than ours that could be viewed by clinicians and payers as functionally equivalent to our solution, offer solutions that may be more accurate or effective than our solutions or offer solutions at prices designed to promote market penetration, which could force us to lower the price of our current and future solutions and affect our ability to achieve or maintain profitability.

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Intellectual Property

Patents and Proprietary Technology

In order to remain competitive, we seek to develop and maintain protection on the proprietary aspects of our technologies. We rely on a combination of patents, copyrights, trademarks, material data transfer agreements and licenses to protect our intellectual property rights. We also rely upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position. We generally protect this information with confidentiality agreements and reasonable security measures.

Our core patent position for AlloMap is based on issued patents and patent applications disclosing identification of genes differentially expressed between activated and resting leukocytes and demonstration of correlation between gene expression patterns and specific clinical states and outcomes. Our strategy is to continue to broaden our intellectual property estate for AlloMap through data science discovery and protection of gene expression patterns and their correlation with specific clinical states and outcomes, as well as the algorithms needed for clinical assessment.

As of December 31, 2018, we had 23 issued U.S. patents related to transplant rejection and autoimmunity.  We have five issued U.S. patents covering methods of diagnosing transplant rejection that use all 11 informative genes measured in AlloMap.  The expiration dates of these patents range from 2021 to 2024.  We have five additional patents covering additional genes or gene variants for diagnosing transplant rejection.  In the area of dd-cfDNA-based transplant diagnostics, we have filed a patent application to cover our research and development work in this field. In connection with our June 2014 acquisition of IMX, we obtained an exclusive license from Stanford to a patent relating to the diagnosis of rejection in organ transplant recipients using dd-cfDNA. This patent has an expiration date of November 5, 2030. A second patent included in the license from Stanford was issued in December 2017 and further covers the use of dd-cfDNA to diagnose and predict transplant status or outcome. As part of our April 2016 acquisition of Allenex, we obtained an additional five U.S. patents on donor matching technology and treatment for antibody mediated transplant rejection. We have six issued U.S. patents covering a method of diagnosing or monitoring autoimmune or chronic inflammatory diseases, such as lupus, by detecting specific genes. While we have clinical samples and patents covering lupus diagnostics, we do not intend to actively pursue the lupus test opportunity.

We have developed trade secrets and know-how since our inception. These trade secrets and know-how are found particularly in technical areas such as optimized systems for making precise and reproducible q-PCR, measurements, and in the analysis of genomic data and algorithm development.

AlloMap, AlloSure, AlloSeq, Olerup SSP, Olerup XM-ONE, QTYPE and CareDx are registered trademarks of ours in the United States.

License Agreements

We currently rely on license agreements to obtain rights under certain patents that we believe may be necessary to make, use and sell our AlloMap and AlloSure tests and future solutions. We may in the future rely, at least in part, upon licensing agreements with third parties to obtain patent rights and transfers of technology, information and know-how that enable us to further our development of additional solutions for post-transplant surveillance.

In November 2004, we entered into a license agreement with Roche Molecular Systems, Inc., or Roche, as amended from time to time, the Roche License. The Roche License grants us the right to use PCR and q-PCR for use in clinical laboratory services. The Roche License is a non-exclusive license agreement in the United States covering the claims in multiple Roche patents. Under the terms of the Roche License, we were required to report and pay royalties, after adjustment due to a discount for combination services, in the mid-single digits on test revenues from products using the licensed intellectual property on a quarterly basis until September 30, 2017, pursuant to a Settlement Agreement and Mutual Release, dated September 11, 2014.  Effective September 30, 2017, no royalties are incurred by us under the Roche License.

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In June 2014, we entered into an amended and restated license agreement with Stanford, which granted us an exclusive license to a patent relating to the diagnosis of rejection in organ transplant recipients using dd-cfDNA and a non-exclusive license to related technology provided by Stanford. Subject to various rights of extension, we are required to achieve certain development and commercialization milestones set forth in the license agreement. Under the terms of the Stanford license, we are required to report and pay an annual license maintenance fee, six milestone payments and royalties in the low single digits on net sales of products incorporating the licensed technology. The license maintenance fee may be offset against earned royalty payments due on net sales in that year.

In May 2018, we entered into the License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina’s next generation sequencing product line for use in transplantation diagnostic testing.

Regulation

Clinical Laboratory Improvement Amendments of 1988

Having a clinical laboratory in California, we are required to hold certain federal, state and local licenses, certifications and permits to conduct our business. Under the CLIA, administered by CMS, we are required to hold a certificate applicable to the type of work we perform and to comply with standards covering personnel, facilities administration, quality systems, proficiency testing and performance. Almost all clinical laboratories are subject to regulation under the CLIA, which is designed to ensure that laboratory testing services performed on materials derived from the human body are accurate and reliable.

We have a certificate of accreditation under the CLIA to perform “high complexity” testing. Laboratories performing high complexity testing are required to meet more stringent personnel and quality system requirements than laboratories performing less complex tests. To renew our CLIA certificate, we are subject to survey and inspection every two years to assess compliance with program standards.  We were inspected as part of the customary College of American Pathologists audit in 2018 and recertified under the CLIA as a result of passing that inspection.

California Laboratory Licensing

In addition to federal certification requirements of laboratories under the CLIA, licensure is required and maintained for our laboratory under California law. Such laws establish standards for the day-to-day operation of a clinical laboratory, including the training and skills required of personnel and quality control. In addition, California laws mandate proficiency testing, which involves testing of specimens that have been specifically prepared for the laboratory. We are required to maintain compliance with California standards as a condition to continued operation of our laboratory in California.

Other States’ Laboratory Testing

Other states require out-of-state laboratories that accept specimens for testing from those states to be licensed. We have obtained licenses in California, Florida, New York, Maryland, Pennsylvania and Rhode Island, and believe we are in compliance with applicable licensing laws.

Food and Drug Administration

The FDA regulates the design, testing, development, manufacture, safety, labeling, marketing, promotion, storage, sale and distribution of medical devices pursuant to its authority under the Federal Food, Drug and Cosmetic Act, or FFDCA. The FFDCA and its implementing regulations govern, among other things, the following activities relating to our medical devices: preclinical and clinical testing, design, manufacture, safety, efficacy, labeling, storage, record keeping, sales and distribution, post-market adverse event reporting, import/export, and advertising and promotion. These regulations apply to all of our products sold in the United States, as well as our facilities in Stockholm, Sweden used to produce some of our products. The FDA has also asserted that it has the authority to regulate laboratory developed tests (“LDTs”) as medical devices under the FFDCA. An LDT is a test developed by a single laboratory for use only in that laboratory, such as AlloMap or AlloSure.

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The FDA has traditionally chosen not to exercise its authority to regulate LDTs because it regulates the primary components in most laboratory-developed tests and because it believes that laboratories certified as high complexity under the CLIA, such as ours, have demonstrated expertise and ability in test procedures and analysis. In the event the FDA changes their policy in regards to “Enforcement discretion” for LDTs, it could require us to modify our business model and incur higher costs in order to maintain compliance with this new policy. A similar situation may occur if Congress decides to enable newly proposed regulations, such as the Verifying Accurate Leading-edge IVCT Development Act of 2018 (the “VALID Act of 2018”). For AlloSure and other similar testing solutions, we may be required to conduct additional clinical trials to demonstrate clinical validity and utility of our test, and submit to the FDA a premarket approval application, or PMA, or 510(k) premarket notification application and obtain approval or clearance for the test subsequent to commercialization. There can be no assurance that any of our tests or additional uses of our tests for which we seek clearance or approval in the future will be cleared or approved on a timely basis, or at all, and there can be no assurance that labeling claims will be consistent with our current claims or adequate to support continued adoption of and reimbursement for our current and future tests. Moreover, any new FDA or regulatory requirements could complicate our compliance efforts.

Health Insurance Portability and Accountability Act

Under the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, the U.S. Department of Health and Human Services, or HHS, has issued regulations to protect the privacy and security of protected health information and standardize data content, codes and formats used in healthcare transactions and the standardized identifiers used by healthcare providers, such as us, and health plans.  

We have developed policies and procedures to comply with these regulations. The requirements under these regulations may change periodically and could have an effect on our business operations if compliance becomes substantially more costly than under current requirements or a significant breach to protected health information (“PHI”) may occur.

In addition to federal privacy regulations, there are a number of state laws governing confidentiality of health information that are applicable to our operations. New laws governing privacy may be adopted in the future as well. We have taken steps to comply with health information privacy requirements to which we are aware that we are subject.

Federal and State Self-Referral Prohibitions

We are subject to the federal self-referral prohibitions, commonly known as the Stark Law, and to similar state restrictions such as California’s Physician Ownership and Referral Act, or PORA. Where applicable, these restrictions generally prohibit us from billing patients or certain governmental or private payers for clinical laboratory testing services when the physician ordering the test, or any member of such physician’s immediate family, has an investment interest in, or compensation arrangement with, us, unless the arrangement meets an exception to the prohibition.

Both the Stark Law and PORA contain exceptions for compensation paid to a physician for personal services rendered by the physician, provided that certain conditions are satisfied. We have compensation arrangements with a number of physicians for personal services, such as speaking engagements. We have structured these arrangements with terms intended to comply with the requirements of the applicable exceptions to the Stark Law and PORA. However, we cannot be certain that regulators would find these arrangements to be in compliance with the Stark Law, PORA or similar state laws.

Sanctions for a violation of the Stark Law include the following:

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Further, a violation of PORA is a misdemeanor and could result in civil penalties and criminal fines. Finally, other states have self-referral restrictions with which we have to comply that differ from those imposed by federal and California law.

Federal and State Fraud and Abuse Laws

Because of the significant federal funding involved in Medicare and Medicaid, Congress and the states have enacted, and actively enforce, a number of laws to eliminate fraud and abuse in federal healthcare programs.  Our business is subject to compliance with these laws.  In March 2010, the Patient Protection and Affordable Care Act, as amended by the Healthcare and Education Affordability Reconciliation Act, or collectively, the Affordable Care Act, was enacted in the United States.  The Affordable Care Act expands the government’s investigative and enforcement authority and increases the penalties for fraud and abuse, including amendments to both the Anti-Kickback Statute and the False Claims Act, to make it easier to bring suit under these statutes. The Affordable Care Act also allocates additional resources and tools for the government to police healthcare fraud, with expanded subpoena power for HHS, additional funding to investigate fraud and abuse across the healthcare system and expanded use of recovery audit contractors for enforcement.

There have been recent public announcements by members of the U.S. Congress and President Trump and his administration regarding their plans to repeal and replace the Affordable Care Act. We cannot predict the ultimate form or timing of any repeal or replacement of the Affordable Care Act or the effect such repeal or replacement would have on our business.

Anti-Kickback Statutes

The federal healthcare programs’ Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as Medicare or Medicaid.

The definition of “remuneration” has been broadly interpreted to include anything of value, including, for example, gifts, certain discounts, the furnishing of free supplies, equipment or services, credit arrangements, payment of cash and waivers of payments.  Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered businesses, the statute has been violated. Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. In addition, violations of the Anti-Kickback Statute also are actionable under the federal False Claims Act.

Many states have adopted laws similar to the Anti-Kickback Statute. Some of these state prohibitions apply to referral of recipients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs.

Federal False Claims Act

The False Claims Act’s “whistleblower” or “qui tam” provisions imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal healthcare program. The qui tam provisions of the False Claims Act allow a private individual to bring actions on behalf of the federal government alleging that the defendant has violated the False Claims Act and to share in any monetary recovery. In recent years, the number of suits brought against healthcare providers by private individuals has increased dramatically. In addition, various states have enacted false claims laws analogous to the False Claims Act, and many of these state laws apply where a claim is submitted to any third-party payer and not merely a federal healthcare program.

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When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 and $11,000 for each separate instance of false claim. There are many potential bases for liability under the False Claims Act. Liability arises, primarily, when an entity knowingly submits or causes another to submit, a false claim for reimbursement to the federal government. The federal government has used the False Claims Act to assert liability on the basis of causing physicians to order excessive or unnecessary services, providing false documentation in support of claims, kickbacks, off-label promotion of products, Stark Law violations and other improper referrals and CLIA violations, in addition to the more predictable allegations as to misrepresentations with respect to the services rendered.  Our future activities relating to billing, compliance with the CLIA and Medicare reimbursement requirements, physician and other healthcare provider financial relationships and the sale and marketing of our products may be subject to scrutiny under these laws.

Foreign Jurisdictions

Laws and regulations outside of the United States also apply to our products. The number and scope of these requirements continues to grow, and there can be no assurance that we will be able to maintain any approvals that may be required to market our pre-transplant line of products outside the United States. Further, there may be significant expense and effort required to comply with these approvals for new products as they become ready for the commercial marketplace or for our existing products that we wish to sell abroad.

We currently produce products, which are CE labeled and subject to the In Vitro Diagnostic Medical Devices Directive (98/79/EC), or IVDD, a European Union, or EU, Directive. Some of our products are currently labeled by self-declaration based on their intended use or certified by a Notified Body for Compliance of the IVDD requirements. A product that is not CE marked is automatically considered to be non-compliant. Appointed national enforcement agencies monitor the market for violations and imported products are checked for compliance at customs offices.

No in vitro device or accessory may be placed on the market or put into service unless it satisfies the essential requirements set forth in the IVDD. Devices considered to meet the essential requirements must bear the CE marking of conformity, placed by the manufacturer, when introduced on the market. A manufacturer placing devices on the market in its name must notify its national competent authorities.

Our products also comply with the CMDCAS, which is a system designed to implement Canadian regulations requiring some medical devices be designed and manufactured under a registered QMS. The SCC and Health Canada's Therapeutic Products Directorate developed this system. CMDCAS came into effect January 1, 2003.

Employees

At December 31, 2018, we had 231 employees, of which 227 were full-time employees. We had 69 employees in manufacturing operations and support, 51 in research and development; 61 in sales and marketing and 50 in general and administrative positions. As of December 31, 2018, 162 employees were located in the United States and 69 were located outside of the United States.

From time to time, we also employ independent contractors, consultants and temporary employees to support our operations. Currently, the Olerup SSP Production Group in Sweden is represented by an IF Metall collective bargaining agreement. None of our other employees are represented by a union or are subject to collective bargaining agreements. We have never experienced a work stoppage and believe that our relations with our employees are good.

Environmental Matters

Our operations require the use of hazardous materials (including biological materials), which subjects us to a variety of federal, state and local environmental and safety laws and regulations. Some of these regulations provide for strict liability, or holding a party potentially liable without regard to fault or negligence. We could be held liable for damages and fines as a result of our, or others’, business operations should contamination of the environment or individual exposure to hazardous substances occur. In addition, we could be subject to significant fines for failure to

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comply with applicable environmental, health and safety requirements. We cannot predict how changes in laws or new regulations will affect our business, operations or the cost of compliance.

Available Information

Our website is www.caredx.com. Information contained on, or that can be accessed through, our website is not part of this Annual Report on Form 10-K, and you should not consider information on our website to be part of this report unless specifically incorporated herein by reference. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our investor relations website as soon as reasonably practicable after we electronically file such material with, or furnish it to the SEC. The SEC also maintains a website that contains our SEC filings. The address of the website is www.sec.gov.

ITEM 1A. RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before investing in our common stock. If any of the follows risks occur, our business, financial condition, results of operations and prospects could be materially harmed. In that event, the market price of our common stock could decline, and you could lose part or all of your investment.

Risks Related to Our Business

We have a history of losses, and we expect to incur net losses for the next several years.

We have incurred substantial net losses since our inception, and we may continue to incur additional losses for the next several years. For the year ended December 31, 2018, our net loss was $46.8 million. As of December 31, 2018, we had an accumulated deficit of $311.8 million. We expect to continue to incur significant operating expenses and anticipate that our expenses will increase due to costs relating to, among other things:

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Even if we achieve significant revenues, we may not become profitable, and even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain consistently profitable could adversely affect the market price of our common stock and could significantly impair our ability to raise capital, expand our business or continue to pursue our growth strategy or even continue to operate. For a detailed discussion of our financial condition and results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We may require additional financing.

As of December 31, 2018, we had cash and cash equivalents of $64.6 million and an accumulated deficit of $311.8 million.  We may require additional financing in the future to fund working capital and pay our obligations as they come due. Additional financing might include issuance of equity securities, debt, cash from collaboration agreements, or a combination of these.  However, there can be no assurance that we will be successful in acquiring additional funding at levels sufficient to fund our operations or on terms favorable to us.  

We receive a substantial portion of our revenues from Medicare, and the loss of, or a significant reduction in, reimbursement from Medicare would severely and adversely affect our financial performance.

For the year ended December 31, 2018, revenue from Medicare for AlloMap and AlloSure represented 62% of testing services revenue. However, we may not be able to maintain or increase our tests reimbursed by Medicare for a variety of reasons, including changes in reimbursement practices, general policy shifts, or reductions in reimbursement amounts. We cannot predict whether Medicare reimbursements will continue at the same payment amount or with the same breadth of coverage in the future, if at all.

The Protecting Access to Medicare Act of 2014, or PAMA includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS would report initially and then on a subsequent three-year basis thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests.  The final PAMA ruling was issued June 17, 2016 and the new market based rates took effect January 1, 2018. The Centers for Medicare & Medicaid Services (“CMS”) will use the rates and volumes reported by laboratories to develop Medicare payment rates for the tests equal to the volume-weighted median of the private payer payment rates for the tests.  Effective January 1, 2018, under PAMA, the reimbursement rate for AlloMap is $3,240 for Medicare beneficiaries, which represents a 14% increase over the 2017 reimbursement rate.

On September 26, 2017, we announced that the Molecular Diagnostic Services, or MolDX, Program developed by Palmetto GBA (“Palmetto”) has set AlloSure reimbursement at $2,841.  AlloSure began to be reimbursed for kidney transplants covered by Medicare across the United States on October 9, 2017, the effective date of the Palmetto local coverage determination, or LCD.

However, if an AlloMap or AlloSure reimbursement rate that is significantly lower than the current rate is set bt CMS or MolDx in the future, it could cause us to discontinue AlloMap or AlloSure testing for Medicare patients because providing tests at a substantially lowered reimbursement rate may not be economically viable.  Given the significant portion of payments represented by Medicare, our remaining test revenue may be insufficient to sustain our operations.

If future reimbursement levels are less than the current price, our revenues and our ability to achieve profitability could be impaired, and the market price of our common stock could decline.  We may also not be able to maintain or increase the portion of our tests reimbursed by Medicare for a variety of other reasons, including changes in reimbursement practices and general policy shifts.

On a five-year rotational basis, Medicare requests bids for its regional Medicare Administrative Contractors (“MAC”) services.  The MAC for California is currently Noridian Healthcare Solutions.  Our current Medicare coverage through Noridian provides for reimbursement for tests performed for qualifying Medicare patients throughout the U.S. so long as the tests are performed in our California laboratory.  We cannot predict whether Noridian or any future MAC will continue to provide reimbursement for AlloMap or AlloSure at the same payment amount or with the same breadth of coverage in the future, if at all.  Additional changes in the MAC processing

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Medicare claims for AlloMap and AlloSure could impact the coverage or payment amount for our tests and our ability to obtain Medicare coverage for any products we may launch in the future.

Any decision by CMS or its local contractors to reduce or deny coverage for our tests would have a significant adverse effect on our revenue and results of operations and ability to operate and raise capital. Any such decision could also cause affected clinicians treating Medicare covered patients to reduce or discontinue the use of our tests.

Our financial results currently are largely dependent on sales of AlloMap and AlloSure tests, and products for pre-transplant matching, and we will need to generate sufficient revenues from these and other solutions and tests we develop to grow our business.

We expect that sales of testing services and products will account for a substantial portion of our revenue for at least the next two years. If we are unable to increase sales of our testing services or products or successfully develop and commercialize other solutions, tests or enhancements, our revenues and ability to achieve profitability would be impaired, and the market price of our common stock could decline.

We could become subject to legal proceedings that could be time consuming, result in costly litigation and settlements/judgments, require significant amounts of management attention and result in the diversion of significant operational resources, which could adversely affect our business, financial condition and results of operations.

We have in the past been, and from time to time in the future may become, involved in lawsuits, claims and proceedings incident to the ordinary course of, or otherwise in connection with, our business. Litigation is inherently unpredictable. It is possible that an adverse result in one or more of these possible future events could have a material adverse effect on us including increased expenses to defend, settle or resolve such litigation.

The development and commercialization of additional diagnostic solutions are key to our growth strategy. New test or product development involves a lengthy and complex process, and we may not be successful in our efforts to develop and commercialize additional diagnostic solutions.

Key elements of our strategy are to discover, develop, validate and commercialize a portfolio of new diagnostic solutions. We cannot be sure that we will be able to successfully complete development of or commercialize any of our planned future solutions, or that they will prove to be capable of reliably being used for organ surveillance in the heart or in other types of organs. Before we can successfully develop and commercialize any of our currently planned or other new diagnostic solutions, we will need to:

This process involves a high degree of risk and may take up to several years or more. Our test development and commercialization efforts may be delayed or fail for many reasons, including:

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Few research and development projects result in commercial products, and success in early clinical studies often is not replicated in later studies. At any point, we may abandon development of new diagnostic solutions, or we may be required to expend considerable resources repeating clinical trials, which would adversely impact the timing for generating potential revenues from those new diagnostic solutions. In addition, as we develop diagnostic solutions, we will have to make additional investments in our sales and marketing operations, which may be prematurely or unnecessarily incurred if the commercial launch of a test is abandoned or delayed. If a clinical validation study fails to demonstrate the prospectively defined endpoints of the study, we would likely abandon the development of the test or test feature that was the subject of the clinical trial, which could harm our business.

If we do not achieve our projected development goals in the time frames we announce and expect, the commercialization of additional diagnostic solutions by us may be delayed and, as a result, our business will suffer and our stock price may decline.

From time to time, we expect to estimate and publicly announce the anticipated timing of the accomplishment of various clinical and other product development goals. In addition, we have included a discussion of a number of anticipated targets elsewhere in this Annual Report on Form 10-K. The actual timing of accomplishment of these targets could vary dramatically compared to our estimates, in some cases for reasons beyond our control. We cannot be certain that we will meet our projected targets and if we do not meet these targets as publicly announced, the commercialization of our diagnostic solutions may be delayed or may not occur at all and, as a result, our business will suffer and our stock price may decline.

The field of diagnostic testing in transplantation is evolving and is subject to rapid technological change. If we are unable to develop solutions to keep pace with rapid medical and scientific change, our operating results could be harmed.

The field of diagnostic testing in transplantation is evolving. Although there have been few advances in technology relating to organ rejection in transplant recipients, the market for medical diagnostic companies is marked by rapid and substantial technological development and innovations that could make AlloMap, AlloSure, products and our solutions in development outdated. We must continually innovate and expand our test offerings to address unmet needs in monitoring transplant related conditions and in pre-transplant testing. AlloMap, AlloSure, products and our solutions in development could become obsolete unless we continually innovate and expand our product offerings to include new clinical applications. If we are unable to demonstrate the effectiveness of AlloMap, AlloSure, products and future diagnostic solutions and tests, if any, compared to new methodologies and technologies, then sales of our solutions and tests could decline, which would harm our business and financial results.

If clinicians, hospital administrators, medical centers and laboratories do not adopt our diagnostic solutions, we will not achieve future sales growth.

Clinicians and healthcare administrators are traditionally slow to adopt new products, testing practices and clinical treatments, partly because of perceived liability risks and the uncertainty of third-party reimbursement. It is critical to the success of our sales efforts that we continue to educate clinicians, administrators and laboratory directors about our testing services and products and, subject to their development, our other solutions, and demonstrate the clinical and diagnostic benefits of these solutions. We believe that clinicians, transplant centers and laboratories may not use our solutions unless they determine, based on published peer-reviewed journal articles, the experience of other clinicians or laboratory verification, that our solutions provide accurate, reliable and cost-effective information that is useful in pre-transplant matching and monitoring their post-transplant recipients.

We estimate that there are approximately 138 centers managing heart transplant recipients in the United States. In 2018, AlloMap was used in 133 of these centers. However, not all clinicians in these centers are currently using our

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test. In order for AlloMap sales to grow, we must continue to market to and educate clinicians and administrators at treatment centers that have used our test to increase the number of clinicians ordering our test, the number of recipients tested and the number of tests per recipient. In addition, we must actively solicit additional treatment centers to establish policies and procedures for ordering our test and to encourage clinicians at those centers to incorporate our test into their standard clinical practice. Some of the challenges that our sales team must overcome include explaining the clinical benefits of AlloMap, which is a highly technical product, and changing a 30-year patient management paradigm of using biopsy as the basis of transplant recipient monitoring.

We estimate that there are approximately 240 centers managing kidney transplant recipients in the United States. In the fourth quarter of 2018, AlloSure was used in 100 of these centers. In order for AlloSure sales to grow, we must continue on our plan to market and educate clinicians and administrators at the treatment centers that have used our test to spread awareness of its effectiveness in creating better long-term care plans for kidney transplant patients.

Our product kits are sold to hundreds of laboratories mainly in Europe and the U.S. Laboratories order our products based on the accuracy, speed and cost of the test together with the cost and availability of equipment on which to run the test. Switching to or adopting our products may require the purchase of new and costly testing equipment. To attract new laboratory customers, the performance of our products must provide an accuracy, speed and/or cost advantage over similar products sold by our competitors.

If clinicians, hospital administrators and laboratories do not adopt and continue to use our tests and products or our future solutions and tests, our business and financial results will suffer.

Our quarterly operating results may fluctuate significantly or may fall below the expectations of investors or securities analysts, each of which may cause our stock price to fluctuate or decline.

Historically, our financial results have been, and we expect that our operating results will continue to be, subject to quarterly fluctuations. Our net income (loss) and other operating results will be affected by numerous factors, including:

If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

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If the use of AlloMap, AlloSure or any of our other solutions is not supported by studies published in peer-reviewed scientific and medical publications, and then periodically supplemented with additional support in peer-reviewed journals, the rate of adoption of our current and future solutions by clinicians and treatment centers and the rate of reimbursement of our current and future solutions by payers may be negatively affected.

The results of our studies involving AlloMap and AlloSure have been presented at major medical society congresses and published in peer-reviewed publications in leading medical journals.  We need to maintain a continued presence in peer-reviewed publications to promote clinician adoption and favorable reimbursement decisions.  We believe that peer-reviewed journal articles that provide evidence of the utility of our solutions or the technology underlying AlloMap, AlloSure or our other solutions are very important to the commercial success of our solutions.  Clinicians typically take a significant amount of time to adopt new products, testing practices and clinical treatments, partly because of perceived liability risks and the uncertainty of third-party reimbursement.  It is critical to the success of our sales efforts that we educate a sufficient number of clinicians and administrators about AlloMap, AlloSure and our future solutions, and demonstrate the clinical benefits of these solutions.  Clinicians may not adopt, and third-party payers may not cover or adequately reimburse for, our current and future solutions unless they determine, based on published peer-reviewed journal articles and the experience of other clinicians, that our diagnostic current and future solutions provide accurate, reliable and cost-effective information that is useful in monitoring transplant recipients and making informed and timely treatment decisions.

The administration of clinical and economic utility studies is expensive and demands significant attention from our management team. Data collected from these studies may not be positive or consistent with our existing data, or may not be statistically significant or compelling to the medical community. If the results obtained from our ongoing or future studies are inconsistent with certain results obtained from our previous studies, adoption of our current and future solutions would suffer and our business would be harmed. While we have had success in generating peer-reviewed publications regarding AlloMap and AlloSure, additional peer-reviewed publications regarding AlloMap, AlloSure and our future solutions may be limited by many factors, including delays in the completion of, poor design of, or lack of compelling data from clinical studies that would be the subject of the article. If our current and future solutions or the technology underlying AlloMap, AlloSure or our future solutions do not receive sufficient favorable exposure in peer-reviewed publications, the rate of clinician adoption and positive reimbursement coverage decisions could be negatively affected. The publication of clinical data in peer-reviewed journals is a crucial step in commercializing and obtaining reimbursement for diagnostic solutions such as ours, and our inability to control when, if ever, results are published may delay or limit our ability to derive sufficient revenue from any product that is the subject of a study.

To ensure the success of AlloSure and future tests based on donor-derived cell-free DNA (“dd-cfDNA”), we will need to continue our efforts to complete and publicize research and trials, especially the Kidney Allograft Outcomes AlloSure Registry (“K-OAR”) registry study, that provides evidence of the utility of dd-cfDNA and validate AlloSure as a solution.

Transplant centers may not adopt AlloMap, AlloSure or our other solutions due to historical practices or due to more favorable reimbursement policies associated with other means of monitoring transplants.

Due to the historically limited monitoring options and the well-established coverage and reimbursement for biopsies, clinicians are accustomed to monitoring for acute cellular rejection in heart transplant recipients by utilizing biopsies. Many clinicians use AlloMap in parallel with biopsies rather than as an alternative to biopsies. While we do not market AlloMap as a biopsy alternative, per se, if treatment center administrators view our test as an alternative to a biopsy and believe they would derive more revenue from the performance of biopsies, such administrators may be motivated to reduce or avoid the use of our test. While biopsies are less common for monitoring kidney transplant patients, there are transplant centers that manage patients with protocol biopsies, which could impact AlloSure revenue. We cannot provide assurance that our efforts will increase the use of our test by new or existing customers. Our failure to increase the frequency of use of our test by new and existing customers would adversely affect our growth and revenues.

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If we are unable to successfully compete with larger and more established players in the clinical surveillance of the transplantation field, we may be unable to increase or sustain our revenues or achieve profitability.

Our AlloMap solution for heart transplant recipients competes against existing diagnostic tests utilized by pathologists, which, in the case of heart transplant rejection, generally involve evaluating biopsy samples to determine the presence or absence of rejection. This practice has been the standard of care in the United States for many years, and we will need to continue to educate clinicians, transplant recipients and payers about the various benefits of our test in order to change clinical practice.

Competition for kidney surveillance diagnostics can also come from biopsies. However, because of the risks and discomforts of the invasive kidney biopsy procedure, as well as the expense and relatively low rate of finding moderate to severe grade rejection, biopsy is not a standard practice for surveillance of transplanted kidneys. Additional competition for kidney surveillance diagnostics currently comes from general, non-specific clinical chemistry tests such as serum creatinine, urine protein, complete blood count, lipid profile and others that are widely ordered by physician offices and routinely performed in clinical reference labs and hospital labs.

We expect the competition for pre-transplant typing and post-transplant surveillance to increase as there are numerous established and startup companies in the process of developing products and services for the transplant market which may directly or indirectly compete with our existing pre- and post-transplant solutions, or our development pipeline. Competition from other companies, especially those with an eye toward transitioning to more automated typing processes, could impact our ability to maintain market share and its current margins. For example, we launched QTYPE in September 2016 and QTYPE competes with other quantitative polymerase chain reaction  products including products offered by Thermo Fisher Scientific, Inc., or Thermo Fisher, as well as alternatives to polymerase chain reaction (“PCR”) such as next generation sequencing (“NGS”) typing products.  In addition to businesses focused on pre-transplantation such as Thermo Fisher’s One Lambda and Immucor, Inc.’s LIFECODES, companies that have not historically focused on transplantation, but that possesses existing knowledge of dd-cfDNA technology have indicated they are considering this market.

The field of clinical surveillance of transplantation is evolving. New and well established companies are devoting substantial resources to the application of molecular diagnostics to the treatment of medical conditions. Some of these companies may elect to develop and market diagnostic solutions in the post-transplant surveillance market.

Many of our potential competitors have greater brand recognition and substantially greater financial and technical resources and development, production and marketing capabilities than we do. Others may develop lower-priced, less complex tests that could be viewed by clinicians and payers as functionally equivalent to our AlloMap and AlloSure tests, which could force us to lower the current list price of our test and impact our operating margins and our ability to achieve profitability. If we are unable to compete successfully against current or future competitors, we may be unable to increase market acceptance for and sales of AlloMap, AlloSure and our future solutions, which could prevent us from increasing or sustaining our revenues or achieving profitability and could cause the market price of our common stock to decline.

If we are unable to successfully and continually update our products on a timely basis, our ability to attract and retain customers could be impaired and our competitive position could be harmed.

We operate in an environment characterized by rapid development and continuing innovation. We will need to continue to maintain the value of our product offering. To compete successfully, we must continually update our product range and produce continually updated test kits and software. The failure to maintain the quality of our products or inability to keep pace with this innovation could render our existing or future solutions obsolete or less attractive to patients. Any failure to anticipate or develop new or enhanced solutions in a timely manner could result in decreased revenue and harm to our business and prospects. If we fail to introduce new or enhanced solutions that meet the needs of our customers, we will lose market share and our business, operating results and prospects will be adversely affected.

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Our research and development efforts will be hindered if we are not able to acquire or contract with third parties for access to additional tissue and blood samples.

Our clinical development relies on our ability to secure access to tissue and blood samples, as well as recipient information including biopsy results and clinical outcomes from the same patient. Furthermore, the studies through which our future solutions are developed may rely on access to multiple samples from the same recipient over a period of time as opposed to samples at a single point in time or archived samples. We will require additional samples and recipient data for future research, development and validation. Access to recipients and samples on a real-time, or non-archived, basis is limited and often on an exclusive basis, and there is no guarantee that future initiatives will be successful in obtaining and validating additional samples. Additionally, the process of negotiating access to new and archived donor and recipient data and samples is lengthy since it typically involves numerous parties and approval levels to resolve complex issues, such as usage rights, institutional review board approval, recipient consent, privacy rights and informed consent of recipients, publication rights, intellectual property ownership and research parameters. If we are not able to acquire or negotiate access to new and archived donor and recipient data and tissue and blood samples with source institutions, or if other laboratories or our competitors secure access to these samples before us, our ability to research, develop and commercialize future solutions such as AlloSure will be limited or delayed.

If we cannot maintain existing clinical collaborations and enter into new ones, our efforts to commercialize and develop products could be delayed.

In the past, we have entered into clinical collaborations with highly regarded academic institutions and leading treatment centers in the transplant field. Our success in the future may depend in part on our ability to enter into agreements with other leading institutions in the transplant field. Securing these agreements can be difficult due to internal and external constraints placed on these organizations. Some organizations may limit the number of collaborations they have with any one company so as to not be perceived as biased or conflicted. Organizations may also have insufficient administrative and related infrastructure to enable collaborations with many companies at once, which can extend the time it takes to develop, negotiate and implement a collaboration. In addition to completing clinical collaborations, publication of clinical data in peer-reviewed journals is a crucial step in commercializing and obtaining coverage and reimbursement for solutions such as ours. Our inability to control when, if ever, results of such studies are published may delay or limit our ability to derive sufficient revenues from any test that may result from a collaboration.

From time to time we expect to engage in discussions with potential clinical collaborators, which may or may not lead to collaborations. We cannot guarantee that any discussions will result in clinical collaborations or that any clinical studies that may result will be enrolled or completed in a reasonable time frame or with successful outcomes. Once news of discussions regarding possible collaborations become known in the medical community, regardless of whether the news is accurate, failure to announce a collaborative agreement or the other entity’s announcement of a collaboration with an entity other than us may result in adverse speculation about us, our current and future solutions or our technology, resulting in harm to our reputation and our business.

If we are unable to successfully manage our growth and support demand for our tests, our business may suffer.

As the volume of the tests that we perform grows, we will need to continue to ramp up our testing capacity, implement increases in scale and related processing, customer service, billing and systems process improvements and expand our internal quality assurance program to support testing on a larger scale. We will also need additional certified laboratory scientists and other scientific and technical personnel to process our tests. We cannot be certain that any increases in scale, related improvements and quality assurance will be successfully implemented or that appropriate personnel will be available. As additional products are developed, we may need to bring new equipment on-line, implement new systems, technology, controls and procedures and hire personnel with different qualifications. We plan to expand our sales force to support additional products. There is significant competition for qualified, productive sales personnel with advanced sales skills and technical knowledge in our field. Our ability to achieve significant growth in revenue in the future will depend, in large part, on our success in recruiting, training and retaining sufficient qualified sales personnel.

The value of AlloMap and AlloSure depends, in large part, on our ability to perform AlloMap and AlloSure tests on a timely basis and at a high quality standard, and on our reputation for such timeliness and quality. Failure to

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implement necessary procedures, transition to new equipment or processes or hire new personnel could result in higher costs of processing or an inability to meet market demand in a timely manner. There can be no assurance that we will be able to perform AlloMap, AlloSure or our future solutions, if any, on a timely basis at a level consistent with demand, that our efforts to scale our commercial operations will not negatively affect the quality of test results or that we will be successful in responding to the growing complexity of our testing operations. If we encounter difficulty meeting market demand for our current and future solutions, our reputation could be harmed and our future prospects and our business could suffer.

In addition, our growth may place a significant strain on our management, operating and financial systems and our sales, marketing and administrative resources. As a result of our growth, our operating costs may escalate even faster than planned, and some of our internal systems may need to be enhanced or replaced. If we cannot effectively manage our expanding operations and our costs, we may not be able to grow effectively or we may grow at a slower pace, and our business could be adversely affected.

Our past testing services revenue growth rates may not be indicative of future growth, and we may not grow at all, and revenue may decline.

From 2017 to 2018, our testing services revenue grew from $33.1 million to $60.3 million, which represents annual growth of 82%. In the future, our revenue may not grow at all and it may decline. We believe that our future revenue will depend on, among other factors:

We may not be successful in our efforts to manage any of the foregoing, and any failure to be successful in these efforts could materially and adversely affect revenue growth. You should not consider our past revenue growth to be indicative of future growth.

If our laboratory facility in the U.S. becomes inoperable, we will be unable to perform AlloMap, AlloSure and future testing solutions, if any, and our business will be harmed.

We perform all of our testing services for the U.S. in our laboratory located in Brisbane, California. We do not have redundant laboratory facilities. Brisbane, California is situated on or near earthquake fault lines. Our facility and the equipment we use to perform testing services would be costly to replace and could require substantial lead time to repair or replace, if damaged or destroyed. Our facilities may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, wildfires, flooding and power outages, which may render it difficult or impossible for us to perform our tests for some period of time. The inability to perform our tests may result in the loss of customers or harm our reputation, and we may be unable to regain those customers in the future. Although we possess insurance for damage to our property and the disruption of our business, we do not have earthquake insurance and thus coverage may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.

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In order to establish a redundant laboratory facility, we would have to spend considerable time and money securing adequate space, constructing the facility, recruiting and training employees, and establishing the additional operational and administrative infrastructure necessary to support a second facility. Additionally, any new clinical laboratory facility opened by us in the U.S. would be required to be certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. We would also be required to secure and maintain state licenses required by several states, including California, Florida, Maryland, New York, Rhode Island and Pennsylvania, which can take a significant amount of time and result in delays in our ability to begin operations at that facility. If we failed to secure any such licenses, we would not be able to process samples from recipients in such states. We also expect that it would be difficult, time-consuming and costly to train, equip and use a third-party to perform tests on our behalf. We could only use another facility with the established state licensures and CLIA certification necessary to perform AlloMap, AlloSure, or future solutions following validation and other required procedures. We cannot be certain that we would be able to find another CLIA-certified facility willing or able to adopt AlloMap, AlloSure or future solutions and comply with the required procedures, or that this laboratory would be willing or able to perform the tests for us on commercially reasonable terms.

Performance issues, service interruptions or price increases by our shipping carriers could adversely affect our business and harm our reputation and ability to provide our services on a timely basis.

Expedited, reliable shipping is essential to our operations. We rely heavily on providers of transport services for reliable and secure point-to-point transport of recipient samples to our laboratory and enhanced tracking of these recipient samples. Should a carrier encounter delivery performance issues such as loss, damage or destruction of a sample, it may be difficult to replace our patient samples in a timely manner and such occurrences may damage our reputation and lead to decreased demand for our services and increased cost and expense to our business. In addition, any significant increase in shipping rates could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions affecting delivery services we use would adversely affect our ability to receive and process recipient samples on a timely basis.

Our ability to commercialize our testing solutions that we develop is dependent on our relationships with laboratory services providers and their willingness to support our current and future solutions.

We rely on third-party laboratory services providers to draw and partially process the patient blood samples that are analyzed in our Brisbane, California laboratory. Our business will suffer if these service providers do not support AlloMap, AlloSure or the other solutions that we may develop. For example, these laboratories may determine that processing the samples for our solutions requires too much additional effort. Additionally, if transplant facilities have relationships with large reference laboratories that will not process and send out our specimens, the clinicians at these facilities may deem ordering our tests outside of these relationships too inconvenient for their patients. A lack of acceptance of our current and future solutions by these service providers could result in lower test volume.

If we are unable to raise additional capital on acceptable terms in the future, it may limit our ability to develop and commercialize new diagnostic solutions and technologies, and we may have to curtail or cease operations.

We expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure, commercial operations and research and development activities. Specifically, we may need to raise additional capital to, among other things:

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Our present and future funding requirements will depend on many factors, including:

Additional capital, if needed, may not be available on satisfactory terms, or at all. Furthermore, if we raise additional funds by issuing equity securities, dilution to our existing stockholders could result. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. For example, we have the ability to sell up to $50.0 million of additional shares of our common stock to the public through an “at the market” offering pursuant to the Sales Agreement we entered into with Jefferies, LLC on August 31, 2018. Any shares of common stock issued in the at-the-market offering will result in dilution to the existing stockholders. If we raise additional funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or our solutions under development, or grant licenses on terms that are not favorable to us, which could lower the economic value of those programs to us. If adequate funds are not available, we may have to scale back our operations or limit our research and development activities, which may cause us to grow at a slower pace, or not at all, and our business could be adversely affected.

The loss of key members of our senior management team or our inability to attract and retain highly skilled scientists, clinicians and laboratory and field personnel could adversely affect our business.

Our success depends largely on the skills, experience and performance of key members of our executive management team. The efforts of each of these persons will be critical to us as we continue to develop our technologies and testing processes and as we attempt to transition to a company with more than one commercialized test.  If we were to lose one or more of these key employees, we may experience difficulties in competing effectively, developing our technologies and implementing our business strategies.

Our research and development programs and commercial laboratory operations depend on our ability to attract and retain highly skilled scientists and technicians, including geneticists, biostatisticians, engineers, licensed laboratory technicians and chemists. We may not be able to attract or retain qualified scientists and technicians in the future due to the intense competition for qualified personnel among life science businesses, particularly in the San Francisco Bay Area. We also face competition from universities, public and private research institutions and other organizations in recruiting and retaining highly qualified scientific personnel.

In addition, our success depends on our ability to attract and retain laboratory and field personnel with extensive experience in transplant recipient care and surveillance and close relationships with clinicians, pathologists and other hospital personnel. We may have difficulties locating, recruiting or retaining qualified salespeople, which could cause a delay or decline in the rate of adoption of AlloMap, AlloSure or our future solutions, if any. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to support our discovery, development, verification and commercialization programs.

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Recent and future acquisitions and investments could disrupt our business, harm our financial condition and operating results, dilute your ownership of us and increase our debt or cause us to incur significant expense.

As part of our business strategy, we may pursue acquisitions of complementary businesses and assets, as well as technology licensing arrangements to expand our existing know-how, expertise and intellectual property in other fields, including for the development of other commercial tests.  We also may pursue strategic alliances that leverage our core technology and industry experience to expand our test offerings or distribution. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not successfully complete acquisitions that we target in the future. Risks we may face in connection with acquisitions include:

Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and investments could cause us to fail to realize the anticipated benefits of these acquisitions or investments, cause us to incur unanticipated liabilities, and harm our business generally. There is also a risk that future acquisitions will result in the incurrence of debt, contingent liabilities, amortization expenses, incremental operating expenses or the write-off of goodwill and other intangible assets, any of which could harm our business and results of operations. We may not identify or complete these transactions in a timely manner, on a cost-effective basis, or at all, and we may not realize the anticipated benefits of any acquisition, technology license, strategic alliance or joint venture.

To finance any acquisitions, we may choose to issue shares of our common stock as consideration, which would dilute your interest in us. If the price of our common stock is low or volatile, we may not be able to acquire other companies using our stock as consideration. Alternatively, it may be necessary for us to raise additional funds for acquisitions through public or private financings. Additional funds may not be available on terms that are favorable to us, or at all.

Undetected errors or defects in our products could result in voluntary corrective actions or agency enforcement actions, including recall of our products, as well as harm our reputation, decrease market acceptance of our products and expose us to product liability or professional liability claims, which could exceed our resources.

Our products may contain undetected errors or defects that are not identified until after the products are first introduced. Disruptions or other performance problems with our products, or the perception of disruption or performance problems with our products, may require us to initiate a product recall, such as the recall occurred in

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April 2016 with respect to one of the Olerup products, and may damage our customers’ businesses and harm our reputation. We may also be subject to warranty and liability claims for damages related to errors or defects in our products. A material liability claim, product recall or similar occurrence may cause us to incur significant expense, decrease market acceptance of our products and adversely impact our business and operating results.

In addition, the marketing, sale and use of AlloMap, AlloSure and our other solutions, or activities related to our research and clinical studies could lead to the filing of product liability claims if someone were to allege that one of our products contained a design or manufacturing defect which resulted in the failure to adequately perform the analysis for which it was designed. For example, a defect in one of our diagnostic solutions could lead to a false positive or false negative result, affecting the eventual diagnosis. Any incomplete or inaccurate analysis on the part of our technicians could also affect the reliability of the test results. A product liability or professional liability claim could result in substantial damages and be costly and time consuming to defend, either of which could materially harm our business or financial condition. We cannot provide assurance that our product liability insurance would adequately protect our assets from the financial impact of defending product liability or professional liability claims or any judgments, fines or settlement costs arising out of any such claims. In addition, any product liability claim brought against us, with or without merit, could increase our product liability insurance rates and prevent us from securing insurance coverage in the future at reasonable coverage levels, or at all. Additionally, any product liability lawsuit could cause injury to our reputation, result in the suspension of our testing pending an investigation into the cause of the alleged failure, or cause current collaborators to terminate existing agreements and potential collaborators to seek other partners, any of which could negatively impact our results of operations.

We rely extensively on third party service providers. Failure of these parties to perform as expected, or interruptions in our relationship with these providers or their provision of services to us, could interfere with our ability to provide test results for our testing services business and kits for our products business.

Our relationship with any of our third party service providers may impair our ability to perform our services. The failure of any of our third party service providers to adequately perform their service obligations may reduce our revenues and increase our expenses or prevent us from providing our products and services in a timely manner if at all. In addition, our reputation, business and financial performance could be materially harmed if we are unable to, or are perceived as unable to provide test kits and perform reliable services.

We rely solely on certain suppliers to supply some of the laboratory instruments and key reagents that we use in the production of our products and/or in the performance of our tests. These sole source suppliers include Thermo Fisher, which supplies us with instruments, laboratory reagents and consumables, Roche Molecular Systems, which supplies us with laboratory reagents and consumables; Illumina, which supplies us with instruments, laboratory reagents, and consumables; Becton, Dickinson and Company, and Streck, which supplies us with cell preparation tubes; Beckman Coulter, which provides laboratory reagents and consumables; and Qiagen N.V., which supplies us with a proprietary buffer reagent. We do not have guaranteed supply agreements with Thermo Fisher, Becton, Dickinson and Company, or Qiagen N.V., which exposes us to the risk that these suppliers may choose to discontinue doing business with us at any time. We periodically forecast our needs to these sole source suppliers and enter into standard purchase orders based on these forecasts.

In addition, our ABI 7900 Thermocycler, a real time PCR instrument used in AlloMap, is no longer in production. Thermo Fisher has committed to provide service and support of this instrument through 2020. We believe that there are relatively few suppliers other than Thermo Fisher, Illumina, Becton, Dickinson and Company and Qiagen N.V. that are currently capable of supplying the instruments, reagents and other supplies necessary for our current products and services. Even if we were to identify secondary suppliers, there can be no assurance that we will be able to enter into agreements with such suppliers on a timely basis on acceptable terms, if at all. If we should encounter delays or difficulties in securing from Thermo Fisher, Becton, Dickinson and Company or Therapak Corporation, or Therapak Corporation encounters delays or difficulties in securing from Qiagen N.V., the quality and quantity of reagents, supplies or instruments that we require for our current products and services or other solutions we develop, we may need to reconfigure our test processes, which would result in delays in commercialization or an interruption in sales. Clinicians and customers who order our current products and services rely on the continued and timely availability of our products and services.  If we are unable to provide results within a timely manner, clinicians may elect not to use our products or services in the future and our business and operating results could be harmed.

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Security breaches, loss of data and other disruptions could compromise sensitive information related to our business or prevent us from accessing critical information and expose us to liability, which could adversely affect our business and our reputation.

We store sensitive intellectual property and other proprietary business information, including that of our customers, payers and collaboration partners. We manage and maintain our applications and data utilizing a combination of on-site systems, managed data center systems and cloud-based data center systems. These applications and data encompass a wide variety of business critical information, including research and development information, commercial information and business and financial information. We work with a third-party billing agent to collect and store sensitive data, including legally-obtained-protected health information, credit card information and personally identifiable information about our customers, payers, recipients and collaboration partners. A data breach or loss of data could have a material adverse effect on our operations, including the potential for material fines and business interruption.

We face four primary risks relative to protecting critical information: loss of access risk, inappropriate disclosure risk, inappropriate modification risk and the risk of our being unable to identify and audit our controls over the first three risks.

We are highly dependent on information technology networks and systems, including the Internet, to securely process, transmit and store our critical information. Security breaches of this infrastructure, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure or modification of confidential information. The secure processing, storage, maintenance and transmission of this critical information are vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure, and that of our third-party billing and collections provider, may be vulnerable to attacks by hackers or viruses or breached due to employee error, malfeasance or other disruptions.

A security breach or privacy violation that leads to disclosure or modification of or prevents access to consumer information (including personally identifiable information or protected health information) could harm our reputation, compel us to comply with disparate state breach notification laws, require us to verify the correctness of database contents and otherwise subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. If we are unable to prevent such security breaches or privacy violations or implement satisfactory remedial measures, our operations could be disrupted, and we may suffer loss of reputation, financial loss and other regulatory penalties because of lost or misappropriated information, including sensitive consumer data. In addition, these breaches and other inappropriate access can be difficult to detect, and any delay in identifying them may lead to increased harm of the type described above.

Any such breach or interruption could compromise our networks or those of our third-party billing agent, and the information stored there could be inaccessible or could be accessed by unauthorized parties, publicly disclosed, lost or stolen. Any such interruption in access, improper access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and regulatory penalties. Unauthorized access, loss or dissemination could also disrupt our operations, including our ability to perform tests, provide test results, bill payers or patients, process claims and appeals, provide customer assistance services, conduct research and development activities, collect, process and prepare company financial information, provide information about our current and future solutions and other patient and clinician education and outreach efforts through our website, and manage the administrative aspects of our business, any of which could damage our reputation and adversely affect our business. Any such breach could also result in the compromise of our trade secrets and other proprietary information, which could adversely affect our competitive position.

In addition, the interpretation and application of consumer, health-related, privacy and data protection laws in the U.S., Europe and elsewhere are often uncertain, contradictory and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. If so, this could result in government-imposed fines or orders requiring that we change our practices, which could adversely affect our business. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices and compliance procedures in a manner adverse to our business.

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International expansion of our business exposes us to business, regulatory, political, operational, financial and economic risks associated with doing business outside of the United States.

As part of our longer-term growth strategy, we intend to target select international markets to grow our presence outside of the U.S. We currently have a commercial agreement for the promotion of AlloMap in Europe with Diaxonhit SA and are distributing AlloMap tests directly in Canada. We also currently distribute products direct in Germany, Austria, Slovenia, Benelux, and in the Nordic countries, and sell products via sub-distributors, in Canada and in significant markets in Europe such as France, Italy, UK and Turkey, and to certain countries in Asia, the Middle East, and Central and South America. To promote the growth of our business internationally, we will need to attract additional partners to expand into new markets. Relying on partners for our sales and marketing subjects us to various risks, including:

If our present or future partners do not perform adequately, or we are unable to enter into agreements in new markets, we may be unable to achieve revenue growth or market acceptance in jurisdictions in which we depend on partners.

In addition, conducting international operations subjects us to risks that, generally, we have not faced in the U.S., including:

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The occurrence of any one of the above could harm our business and, consequently, our revenues and results of operations. Our expanding international operations could be affected by changes in laws, trade regulations, labor and employment regulations, and procedures and actions affecting approval, production, pricing, reimbursement and marketing of our current and future solutions, as well as by inter-governmental disputes. Any of these changes could adversely affect our business. Additionally, operating internationally requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required in establishing operations in other countries will produce desired levels of revenue or profitability.

In addition, any failure to comply with applicable legal and regulatory obligations could impact us in a variety of ways that include, but are not limited to, significant criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments, and restrictions on certain business activities. Also, the failure to comply with applicable legal and regulatory obligations could result in the disruption of our distribution and sales activities.

Our success expanding internationally will depend, in part, on our ability to develop and implement policies and strategies that are effective in anticipating and managing these and other risks in the countries in which we do business. Failure to manage these and other risks may have a material adverse effect on our operations in any particular country and on our business as a whole.

Our operating results may be adversely affected by unfavorable economic and market conditions.

Many of the countries in which we operate, including the U.S. and several of the members of the European Union (“EU”), have experienced and continue to experience uncertain economic conditions resulting from global as well as local factors. On June 23, 2016, the United Kingdom, or the UK, held a referendum pursuant to which voters elected to leave the EU, commonly referred to as Brexit. Although the effects of Brexit will depend on any agreements between the UK and the EU, Brexit has created additional uncertainties that may ultimately result in new regulatory costs and challenges for companies and increased restrictions on imports and exports throughout Europe, which could adversely affect our ability to conduct and expand our operations in Europe and which may have an adverse effect on our business, financial condition and results of operations.

Our business or financial results may be adversely impacted by these uncertain economic conditions, including: adverse changes in interest rates, foreign currency exchange rates, tax laws or tax rates; inflation; contraction in the availability of credit in the marketplace due to legislation or other economic conditions, which may potentially impair our ability to access the capital markets on terms acceptable to us or at all; and the effects of government initiatives to manage economic conditions. In addition, we cannot predict how future economic conditions will

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affect our critical customers, suppliers and distributors and any negative impact on our critical customers, suppliers or distributors may also have an adverse impact on our results of operations or financial condition.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017, the Tax Act, was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017.  We calculated the impact of the Tax Act in its year end income tax provision in accordance with its understanding of the Tax Act and guidance available as of the date of this filing which did not result in any additional income tax expense in the fourth quarter of 2017.  The enactment of the Tax Act also requires companies to recognize the effects of changes in tax laws and rates on deferred tax assets and liabilities and the retroactive effects of changes in tax laws in the period in which the new legislation is enacted.  Consequently, we accounted for a provisional estimated reduction of the U.S. deferred tax assets from $72.5 million to approximately $45.9 million with a corresponding decrease of $27.0 million to our valuation allowance. We completed its analysis of the impacts of the 2017 Tax Act in the fourth quarter of 2018 with no net change to its provisional estimates due to the valuation allowance.

The Tax Cuts and Jobs Act of 2017 also implemented global intangible low tax income (“GILTI”) which is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations as well as the new base erosion anti-abuse tax (“BEAT”) under the Tax Act. GILTI will be effectively taxed at a tax rate of 10.5%.  Due to the complexity of the GILTI tax rules, companies are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred or (2) factoring such amounts into a company’s measurement of its deferred taxes.  We have not made an election with respect to GILTI as it is not applicable to us in 2018. We will continue to review the GILTI and BEAT rules to determine their applicability to us and the impact that the rules may have on our results of operations of financial condition.

Our insurance policies are expensive and protect us only from some business risks, which will leave us exposed to significant uninsured liabilities.

We do not carry insurance for all categories of risk that our business may encounter. For example, we do not carry earthquake insurance. In the event of a major earthquake in our region, our business could suffer significant and uninsured damage and loss. Some of the policies we currently maintain include general liability, foreign liability, employee benefits liability, property, automobile, umbrella, workers’ compensation, products liability and directors’ and officers’ insurance. We do not know, however, if we will be able to maintain existing insurance with adequate levels of coverage. Any significant uninsured liability may require us to pay substantial amounts, which would adversely affect our cash position and results of operations.

If we use hazardous materials in a manner that causes injury, we could be liable for damages.

Our activities currently require the use of hazardous chemicals. We cannot eliminate the risk of accidental contamination or injury to employees or third parties from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our resources or any applicable insurance coverage we may have. Additionally, we are subject on an ongoing basis to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products.

We may use third party collaborators to help us develop, validate or commercialize any new diagnostic solutions, and our ability to commercialize such solutions could be impaired or delayed if these collaborations are unsuccessful.

We may in the future selectively pursue strategic collaborations for the development, validation and commercialization of any new diagnostic solutions we may develop. In any future third party collaboration, we may be dependent upon the success of the collaborators in performing their responsibilities and their continued cooperation. Our collaborators may not cooperate with us or perform their obligations under our agreements with them. We cannot control the amount and timing of our collaborators’ resources that will be devoted to performing their responsibilities under our agreements with them. Our collaborators may choose to pursue alternative technologies in preference to those being developed in collaboration with us. The development, validation and commercialization of our potential solutions may be delayed if collaborators fail to fulfill their responsibilities in a

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timely manner or in accordance with applicable regulatory requirements or if they breach or terminate their collaboration agreements with us. Any issues arising from these arrangements will affect our ability to serve the entire region, and our reputation may suffer even if we subsequently locate new partners, which may permanently affect our business. Disputes with our collaborators could also impair our reputation or result in development delays, decreased revenues and litigation expenses.

Changes in, or interpretations of, accounting rules and regulations could result in unfavorable accounting changes or require us to change our compensation policies.

Accounting methods and policies for diagnostic companies, including policies governing revenue recognition, research and development and related expenses and accounting for stock-based compensation, are subject to further review, interpretation and guidance from relevant accounting authorities, including the SEC. Changes to, or interpretations of, accounting methods or policies may require us to reclassify, restate or otherwise change or revise our consolidated financial statements, including those contained in this Annual Report on Form 10-K. In addition, the preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Any changes or modifications to the methodology used for determining our estimates, assumptions and forecasts could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Acquisitions

Intangibles, including goodwill, acquired in connection with acquisitions may subsequently be impaired and, if so, could increase our net accumulated deficit.

Under United States Generally Accepted Accounting Principles (“U.S. GAAP”), we are required to evaluate our goodwill and indefinite-lived intangibles for impairment when events or changes in circumstances indicate the carrying value may not be recoverable; specifically, we are required to evaluate whether the intangible assets and goodwill as a result of an acquisition continue to have a fair value that meets or exceeds the amounts recorded on our balance sheet. We test goodwill and indefinite-lived intangibles for impairment at least annually and more frequently if impairment indicators are present. If the fair values of such assets decline below their carrying value on the balance sheet, we may be required to recognize an impairment charge related to such decline.

Under U.S. GAAP, we are also required to evaluate finite-lived intangible assets, which are long-lived assets, for indicators of possible impairment at least annually and more frequently when events or changes in circumstances indicate the carrying amount of the intangible asset may not be recoverable. Finite-lived intangible assets are intangible assets that we are amortizing over their estimated useful lives. If recoverability is in question, we would then compare the carrying amounts of the intangible assets with the future net undiscounted cash flows expected to be generated by such asset. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the intangible asset over the asset’s fair value determined using discounted estimates of future cash flows.

Lower than expected revenue growth, a trend of weaker than anticipated financial performance, a decline in our market capitalization for a sustained period of time, unfavorable changes in market or economic and industry conditions all could significantly impact our impairment analysis. If we determine an impairment exists, we may be required to recognize further impairment charges that, if incurred, could have a material adverse effect on our financial condition and results of operations.

Our License and Commercialization Agreement with Illumina may not result in material benefits to our business.

Under the License and Commercialization Agreement (the “License Agreement”) with Illumina, Inc. (“Illumina”), we are obligated to complete timely development and commercialization of future products, including meeting certain commercialization milestones. The failure to meet any such milestones could result in the loss of exclusivity for the affected licensed products. Additionally, we agreed to minimum purchase commitments of finished products and raw materials from Illumina through 2023 and we are required to pay royalties in the mid-single to low-double digits on sales of future commercialized products.

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We cannot make any assurances that our efforts under the License Agreement will be successful. As a result, we may not be able to fully realize the anticipated strategic benefits of the License Agreement. If we fail to successfully execute on the License Agreement, we may not realize the benefits expected from the transaction and our business may be harmed.

Risks Related to Billing and Reimbursement

Billing complexities associated with obtaining payment or reimbursement for our current and future solutions may negatively affect our revenue, cash flows and profitability.

Billing for clinical laboratory testing services is complex. In cases where we do not have a contract in place requiring the payment of a fixed fee per test, we perform tests in advance of payment and without certainty as to the outcome of the billing process. In cases where we do receive a fixed fee per test, we may still have disputes over pricing and billing. We receive payment from individual recipients and from a variety of payers, such as commercial insurance carriers and governmental programs, primarily Medicare. Each payer typically has different billing requirements. Among the factors complicating our billing of third-party payers are:

Additionally, from time to time, payers change processes that may affect timely payment. For example, some commercial payers have instituted prior authorization requirements before our testing is performed. These changes may result in uneven cash flow or impact the timing of revenue recognized with these payers. With respect to payments received from governmental programs, factors such as a prolonged government shutdown could cause significant regulatory delays or could result in attempts to reduce payments made to us by federal government healthcare programs. In addition, payers may refuse to ultimately make payment if their processes and requirements have not been met on a timely basis. These billing complexities, and the resulting uncertainty in obtaining payment for AlloMap, AlloSure and future solutions, could negatively affect our revenue, cash flows and profitability.

Health insurers and other third-party payers may decide to revoke coverage of our existing test, decide not to cover our future solutions or may provide inadequate reimbursement, which could jeopardize our commercial prospects.

Successful commercialization of AlloMap and AlloSure depends, in large part, on the availability of coverage and adequate reimbursement from government and private payers. Favorable third-party payer coverage and reimbursement are essential to meeting our immediate objectives and long-term commercial goals.  Throughout 2017, we did not recognize revenue for test results delivered without a contract for reimbursement, or an established coverage policy and a history of payment. The revenue recognition criteria for cash basis payers changed effective January 1, 2018 under Accounting Standards Codification, or ASC, Topic 606, Revenue from Contracts with Customers, or ASC 606. Revenue for AlloMap and AlloSure tests is estimated based on historical reimbursements received from payers.

For new diagnostic testing services, each private and government payer decides whether to cover the test, the amount it will reimburse for a covered test and the specific conditions for reimbursement. Clinicians and recipients may be likely not to order a diagnostic test unless third-party payers pay a substantial portion of the test price. Therefore, coverage determinations and reimbursement levels and conditions are critical to the commercial success of a diagnostic testing service, and if we are not able to secure positive coverage determinations and reimbursement levels, our business will be materially adversely affected.

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Coverage and reimbursement by a commercial payer may depend on a number of factors, including a payer’s determination that our current and future testing services are:

In addition, several payers and other entities conduct technology assessments of new medical tests and devices and provide and/or sell the results of their assessments to other parties. These assessments may be used by third-party payers and healthcare providers as grounds to deny coverage for or refuse to use a test or procedure. We believe we have received a negative technology assessment from at least one of these entities and could receive more.

If third-party payers decide not to cover our diagnostic testing services or if they offer inadequate payment amounts, our ability to generate revenue from AlloMap, AlloSure and future solutions could be limited. Payment for diagnostic tests furnished to Medicare beneficiaries is typically made based on a fee schedule set by CMS. In recent years, payments under these fee schedules have decreased and may decrease further. Any third-party payer may stop or lower payment at any time, which could substantially reduce our revenue. See the risk factor above titled “We receive a substantial portion of our revenues from Medicare, and the loss of, or a significant reduction in, reimbursement from Medicare would severely and adversely affect our financial performance”.

Since each payer makes its own decision as to whether to establish a policy to reimburse for a test, seeking payer coverage and other approvals is a time-consuming and costly process. We cannot be certain that adequate coverage and reimbursement for AlloMap, AlloSure or future solutions will be provided in the future by any third-party payer.

Reimbursement for AlloMap and AlloSure comes primarily from Medicare, private third party payers such as insurance companies and managed care organizations, Medicaid and hospitals. The reimbursement process can take six months or more to complete depending on the payer. Coverage policies approving AlloMap have been adopted by many of the largest private payers, including Aetna, Anthem, Cigna, Health Care Services Corporation (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE, and UnitedHealthcare. Many of the payers with positive coverage policies have also entered into contracts with us to formalize pricing and payment terms.  We continue to work with third-party payers to expand and seek such coverage and to appeal denial decisions based on existing and ongoing studies, peer reviewed publications, support from physician and patient groups and the growing number of AlloMap tests that have been reimbursed by public and private payers.  There are no assurances that the current policies will not be modified in the future.  If our test is considered on a policy-wide level by major third-party payers, whether at our request or on their own initiative, and our test is determined to be ineligible for coverage and reimbursement by such payers, our collection efforts and potential for revenue growth could be adversely impacted.

Our Medicare Part B coverage for AlloMap and AlloSure is included in a formal local coverage decision for molecular diagnostics.  However, any change in this coverage decision or other future adverse coverage decisions by the CMS, including with respect to coding, could substantially reduce our revenue.

Medicare reimbursements currently comprise a significant portion of our revenue. Our current Medicare Part B reimbursement was not set pursuant to a national coverage determination by CMS. Although we believe that coverage is available under Medicare Part B even without such a determination, we currently lack the national coverage certainty afforded by a formal coverage determination by CMS. This means that Medicare contractors, including our California Medicare contractor, currently may continue to develop their own coverage and reimbursement policies with respect to our technology.

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Until 2016, AlloMap was billed using an unlisted Current Procedural Terminology (“CPT”) code, but in 2016 a new CPT Category 1 Multianalyte Assays with Algorithmic Analyses, or MAAA, code was added that specifically describes the test. Further, pursuant to MolDX billing requirements, the AlloMap test also has been assigned a McKesson Diagnostics Z code^TM which is included on all Medicare claims. If in the future CMS makes a determination not to pay for this code, or for any MAAA codes, this could be harmful to our business, and could have negative spillover implications that prevent or limit coverage by other third-party payers that might mirror aspects of Medicare payment criteria.

Since the launch of AlloSure in October 2016, and at the instruction of the MolDX Program of Palmetto, the test has been billed utilizing an unlisted CPT code.  If in the future CMS makes a determination to no longer provide coverage for services billed with an unlisted CPT code, our ability to bill and obtain reimbursement from public and private payers could be negatively impacted.

Healthcare reform measures could hinder or prevent the commercial success of AlloMap and AlloSure.

The pricing and reimbursement environment may change in the future and become more challenging as a result of any of several possible regulatory developments, including policies advanced by the U.S. government, new healthcare legislation or fiscal challenges faced by government health administration authorities. Specifically, there have been a number of legislative and regulatory proposals and initiatives to change the healthcare system in ways that could affect our ability to profitably sell any diagnostic products we may develop and commercialize. Some of these proposed and implemented reforms could result in reduced reimbursement rates for our diagnostic products from governmental agencies or other third-party payers, which would adversely affect our business strategy, operations and financial results. For example, as a result of the Patient Protection and Affordable Care Act of 2010 (as amended by the Health Care and Education Reconciliation Act of 2010), or collectively, the Affordable Care Act, substantial changes have been made and may continue to be made to the current system for paying for healthcare in the U.S., including changes made in order to extend medical benefits to those who currently lack insurance coverage. The Affordable Care Act also provided that payments under the Medicare CLFS were to receive a negative 1.75% annual adjustment through 2015. Although we have not been subject to such adjustment in the past, we cannot be certain that the claims administrators will not attempt to apply this adjustment in the future.

Among other things, the Affordable Care Act includes payment reductions to Medicare Advantage plans. These cuts have been mitigated in part by a CMS demonstration program that expired in 2015. We cannot be assured that future cuts would be mitigated by CMS. Any reductions in payment to Medicare Advantage plans could materially impact coverage and reimbursement for AlloMap.

In addition to the Affordable Care Act, various healthcare reform proposals have also emerged from federal and state governments. For example, in February 2012, Congress passed the “Middle Class Tax Relief and Job Creation Act of 2012” which in part reduced the potential future cost-based increases to the Medicare CLFS by 2%. The Protecting Access to Medicare Act of 2014 introduced a multi-year phase in of a new payment system for services paid under the CLFS. Under this new system, beginning in 2017 laboratories began reporting to CMS the payment rates paid to the laboratories by commercial third-party payers including Medicare and Medicaid managed care plans, for each test and the volume of each test performed. CMS began using the reported data to set new payment rates under the CLFS in 2018. For most tests, rates will only be adjusted every three years. For newly developed tests that are considered to be “advanced diagnostic lab tests,” the Medicare payment rate will be the actual list price offered to third-party payers for the first three quarters that the tests are offered, subject to later adjustment. CMS will establish subsequent payment rates using the commercial third-party payer data reported for those tests.

There have been recent public announcements by members of the U.S. Congress and President Trump and his administration regarding their plans to repeal and replace the Affordable Care Act. We cannot predict the ultimate form or timing of any repeal or replacement of the Affordable Care Act or the effect such repeal or replacement would have on our business. Regardless of the impact of any or repeal or replacement of the Affordable Care Act on us, the government has shown significant interest in pursuing healthcare reform and reducing healthcare costs. Any government-adopted reform measures could decrease the amount of reimbursement available from governmental and other third-party payers. On April 1, 2013, cuts to the federal budget resulting from sequestration were implemented, requiring a 2% cut in Medicare payment for all services, including AlloMap and AlloSure. Federal budgetary limitations and changes in healthcare policy, such as the creation of broad limits for diagnostic products

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or requirements that Medicare patients pay for portions of clinical laboratory tests or services received, could substantially diminish the sale, or inhibit the utilization, of AlloMap, AlloSure and our future diagnostic solutions, increase costs, divert management’s attention and adversely affect our ability to generate revenue and achieve profitability.

Risks Related to the Healthcare Regulatory Environment

In order to operate our laboratory, we have to comply with the CLIA and state laws governing clinical laboratories.

We are subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens taken from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. If our laboratory is out of compliance with CLIA requirements, we may be subject to sanctions such as suspension, limitation or revocation of our CLIA certificate, as well as a direct plan of correction, state on-site monitoring, civil money penalties, civil injunctive suit or criminal penalties. We must maintain CLIA compliance and certification to

be eligible to bill for services provided to Medicare beneficiaries. If we were to be found to be out of compliance with CLIA program requirements and subjected to sanction, our business could be materially harmed.

Licensure is also required for our laboratory under California law in order to conduct testing. California laws establish standards for day-to-day operation of our clinical laboratory, including the training and skills required of personnel and quality control. Moreover, several states, including New York, require that we hold licenses to test specimens from patients residing in those states. Other states have similar requirements or may adopt similar requirements in the future. In addition to our California certifications, we currently hold licenses in Florida, Maryland, New York, Pennsylvania and Rhode Island. The loss of any of these state certifications would impact our ability to provide services in those states, which could negatively affect our business. Finally, we may be subject to regulation in foreign jurisdictions where we offer our test. Failure to maintain certification in those states or countries where it is required could prevent us from testing samples from those states or countries, could lead to the suspension or loss of licenses, certificates or authorizations, and could have an adverse effect on our business.

We were inspected as part of the customary College of American Pathologists audit and recertified in February 2018 as a result of passing that inspection. We expect the next regular inspection under CLIA to occur in 2020. If we were to lose our CLIA accreditation or California license, whether as a result of a revocation, suspension or limitation, we would no longer be able to perform AlloMap or AlloSure, which would limit our revenues and materially harm our business. If we were to lose our license in other states where we are required to hold licenses, we would not be able to test specimens from those states, which could also have a material adverse effect on our business.

The FDA has traditionally chosen not to exercise its authority to regulate laboratory developed tests (“LDTs”) because it believes that laboratories certified as high complexity under CLIA, such as ours, have demonstrated expertise and ability in test procedures and analysis. However, beginning in September 2006, the FDA issued draft guidance on a subset of LDTs known as “in vitro diagnostic multivariate index assays,” or IVDMIAs. According to the draft guidance, IVDMIAs do not fall within the scope of LDTs over which the FDA has exercised enforcement discretion because such tests incorporate complex and unique interpretation functions which require clinical validation. We believed that AlloMap met the definition of IVDMIA set forth in the draft guidance document. As a result, we applied for, and obtained in August 2008, 510(k) clearance for AlloMap for marketing and sale as a test to aid in the identification of recipients with a low probability of moderate or severe rejection. A 510(k) submission is a premarketing submission made to the FDA. Clearance may be granted by the FDA if it finds the device or test provides satisfactory evidence pertaining to the claimed intended uses and indications for the device or test.

While we believe that we are currently in material compliance with applicable laws and regulations relating to our LDTs, we cannot be certain that the FDA or other regulatory agencies would agree with our determination. A determination that we have violated these laws, or a public announcement that we are being investigated for possible violation of these laws, could hurt our business and our reputation.

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If we were required to conduct additional clinical trials prior to marketing our solutions under development, those trials could lead to delays or a failure to obtain necessary regulatory approvals and harm our ability to be profitable.

If the FDA or the Congress decide to regulate AlloSure and other future solutions under development as medical devices, it could require additional premarket clinical testing subsequent to commercialization in the case of AlloSure and/or prior to submitting a regulatory application for commercial sales for future products not yet developed.  If we are required to conduct premarket clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase our development costs and delay test commercialization and also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient blood or tissue samples or insufficient data regarding the associated clinical outcomes. We may find it necessary to engage contract research organizations to perform data collection and analysis and other aspects of our clinical trials, which might increase the cost and complexity of our trials and reduce our control over such activities. If these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality, completeness or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols, applicable regulatory requirements, or for other reasons, our clinical trials may have to be extended, delayed or terminated. We may not be able to enter into replacement arrangements without undue delays or considerable expenditures. In addition, we may not be able to establish or maintain relationships with these parties on favorable terms, if at all. Each of these outcomes would harm our ability to market our solutions under development and our ability to be profitable.

Any test for which we obtain regulatory clearance will be subject to extensive ongoing regulatory requirements, and we may be subject to penalties if we or our contractors or commercial partners fail to comply with regulatory requirements or if we experience unanticipated problems with our products.

AlloMap, AlloSure and our other solutions, along with the manufacturing processes, packaging, labeling, distribution, import, export, and advertising and promotional activities for such solutions or devices, are or will be subject to continual requirements of, and review by, CMS, state licensing agencies, the FDA and comparable regulatory authorities. These requirements include submissions of safety and other post-marketing information and reports, registration and listing requirements, requirements relating to quality control, quality assurance and corresponding maintenance of records and documents, requirements relating to product labeling, advertising, promotion, recordkeeping and adverse event reporting. Regulatory clearance of a test or device may be subject to limitations by the regulatory body as to the indicated uses for which the product may be marketed or to other conditions of approval. For example, we are exploring utilization of AlloMap in areas that could be considered outside the scope of our current labeling. Broader uses would require FDA clearance as well as changes to the labeling. In addition, clearance may contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the test or device. Discovery of previously-unknown problems with our current or future solutions, or failure to comply with regulatory requirements, may result in actions such as:

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We are subject to numerous fraud and abuse and other laws and regulations pertaining to our business, the violation of any one of which could harm our business.

The clinical laboratory testing industry is highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely in the future. Our arrangements with customers may expose us to broadly applicable fraud and abuse and other laws and regulations that may restrict the financial arrangements and relationships through which we market, sell and distribute our products. Our employees, consultants, principal investigators and commercial partners may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements. In addition to CLIA regulation, other federal and state healthcare laws and regulations that may affect our ability to conduct business, include, without limitation:

Because of the breadth of these laws and the narrowness of available statutory and regulatory exemptions, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Any action brought against us for violation of these laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. We may be subject to private “qui tam” actions brought by individual whistleblowers on behalf of the

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federal or state governments, with potential liability under the federal False Claims Act, including mandatory treble damages and significant per-claim penalties. If our operations are found to be in violation of any of the federal, state and foreign laws described above or any other current or future fraud and abuse or other healthcare laws and regulations that apply to us, we may be subject to penalties, including significant criminal, civil, and administrative penalties, damages, fines, imprisonment for individuals, exclusion from participation in government programs, such as Medicare and Medicaid, injunctions, recall or seizure of products, total or partial suspension of production, denial or withdrawal of pre-marketing product approvals, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our results of operations. Any of the foregoing consequences could seriously harm our business and our financial results.

Foreign governments may impose reimbursement standards, which may adversely affect our future profitability.

When we market AlloMap, our products and our solutions under development in foreign jurisdictions, we are subject to rules and regulations in those jurisdictions. In some foreign countries, including countries in the EU, the reimbursement of our current and future solutions is subject to governmental control. In these countries, reimbursement negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a test candidate. If reimbursement of our future solutions in any jurisdiction is unavailable or limited in scope or amount, or if reimbursement rates are set at unsatisfactory levels, we may be unable to, or decide not to, market our test in that jurisdiction.

Changes in healthcare policy could increase our costs and subject us to additional regulatory requirements that may interrupt commercialization of our current and future solutions.

Changes in healthcare policy could increase our costs, decrease our revenues and impact sales of and reimbursement for our current and future solutions. In March 2010, the Affordable Care Act became law. This law substantially changed the way healthcare is financed by both governmental and private insurers, and contained a number of provisions that have impacted our business and operations, including those governing enrollment in federal healthcare programs, reimbursement changes and fraud and abuse enforcement. Further, our combination with Allenex will also change how these provisions could impact our business.

PAMA, includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS report initially and then on a subsequent three-year basis thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests. The new PAMA rules took effect January 1, 2018 and used the rates and volumes reported by laboratories to develop Medicare payment rates for the tests equal to the volume-weighted median of the private payer payment rates for the tests.

In addition to the Affordable Care Act, there will continue to be proposals by legislators at both the federal and state levels, regulators and third-party payers to reduce costs while expanding individual healthcare benefits. Certain of these changes could impose additional limitations on the prices we will be able to charge for our current and future solutions or the amounts of reimbursement available for our current and future solutions from governmental agencies or third-party payers. While in general it is difficult to predict specifically what effects the Affordable Care Act or any future healthcare reform legislation or policies will have on our business, current and future healthcare reform legislation and policies could have a material adverse effect on our business and financial condition.

Risks Related to Our Intellectual Property

Our competitive position depends on maintaining intellectual property protection.

Our ability to compete and to achieve and maintain profitability depends on our ability to protect our proprietary discoveries and technologies. We currently rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements and license agreements to protect our intellectual property rights.

Our patent position for AlloMap is based on issued patents and patent applications disclosing identification of genes differentially expressed between activated and resting leukocytes and demonstration of correlation between gene expression patterns and specific clinical states and outcomes. Our strategy is to continue to broaden our intellectual

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property estate for AlloMap through the discovery and protection of gene expression patterns and their correlation with specific clinical states and outcomes, as well as the algorithms needed for clinical assessment.

As of December 31, 2018, we had 23 issued U.S. patents related to transplant rejection and autoimmunity. We have five issued U.S. patents covering methods of diagnosing transplant rejection using all 11 informative genes measured in AlloMap. The expiration dates of these patents range from 2021 to 2024. We have five additional patents covering additional genes or gene variants for diagnosing transplant rejection.

As part of our April 2016 acquisition of Allenex, we obtained an additional five U.S. patents on donor matching technology treatment for antibody mediated transplant rejection.  We have six issued U.S. patents covering a method of diagnosing or monitoring autoimmune or chronic inflammatory disease, such as lupus, by detecting specific genes. While we have clinical samples and patents covering lupus diagnostics, we do not intend to actively pursue the lupus test opportunity.

In the area of dd-cfDNA-based transplant diagnostics, we have submitted a patent application to cover some of our research and development work in this field. There is no guarantee that the U.S. Patent and Trademark Office, or PTO, will approve this application. We do not know what claims, if any, will be granted in our existing and future applications. Our patents and patents that we exclusively license from others address fields that are rapidly evolving, and, particularly with respect to dd-cfDNA-based transplant diagnostics, it is possible that other patents have and will be granted to others that affect our ability to develop and commercialize our current and future solutions. If the reviewers of our patent applications at the PTO refuse our claims, we may not be able to sufficiently protect our intellectual property. Further, recent and future changes in the patent laws and regulations of the United States and other jurisdictions may require us to modify our patent strategy and could restrict our ability to obtain additional patents for our technology.

In connection with our June 2014 acquisition of IMX, we obtained an exclusive license from Stanford to a U.S. patent relating to the diagnosis of rejection in organ transplant recipients using dd-cfDNA. This patent has an expiration date of November 5, 2030.  A second patent included in the license from Stanford was issued in December 2017 and further covers the use of dd-cfDNA to diagnose and predict transplant status or outcome.

Our patents and the patents we exclusively license from others may be successfully challenged by third parties as being invalid or unenforceable. Third parties may independently develop similar or competing technology that avoids the patents we own or exclusively license. We cannot be certain that the steps we have taken will prevent the misappropriation and use of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

The extent to which the patent rights of life sciences companies effectively protect their products and technologies is often highly uncertain and involves complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the proper scope of allowable claims of patents held by such companies has emerged to date in the United States. Various courts, including the United States Supreme Court, have rendered decisions that impact the scope of patentability of certain inventions or discoveries relating to diagnostic solutions or genomic diagnostics. In the Ariosa Diagnostics, Inc. v. Sequenom, Inc. (Fed. Cir. 2015) case, a federal court recently determined that a dd-cfDNA product for fetal testing was not eligible for patent protection. These decisions generally stand for the proposition that inventions that recite laws of nature are not themselves patentable unless they have sufficient additional features that provide practical assurance that the processes are genuine inventive applications of those laws rather than patent drafting efforts designed to monopolize a law of nature itself. What constitutes a “sufficient” additional feature for this purpose is uncertain. This evolving case law in the United States may adversely impact our ability to obtain new patents and may facilitate third-party challenges to our existing owned and exclusively licensed patents.

Changes in either the patent laws or in interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property rights. In particular, in September 2011, the United States Congress passed the Leahy-Smith America Invents Act, or the AIA, which became effective in March 2013. The AIA reforms United States patent law in part by changing the standard for patent approval for certain patents from a “first to invent” standard to a “first to file” standard and developing a post-grant review system. This has not yet had a material impact on the operation of our business and the protection and enforcement of our intellectual property, but it may in the

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future. The AIA and its implementation could still increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business and financial condition. Patent applications in the United States and many foreign jurisdictions are not published until at least eighteen months after filing, and it is possible for a patent application filed in the United States to be maintained in secrecy until a patent is issued on the application. In addition, publications in the scientific literature often lag behind actual discoveries. We therefore cannot be certain that others have not filed patent applications that cover inventions that are the subject of pending applications that we own or exclusively license or that we or our licensors, as applicable, were the first to invent the technology (pre-AIA) or first to file (post-AIA). Our competitors may have filed, and may in the future file, patent applications covering technology that is similar to or the same as our technology. Any such patent application may have priority over patent applications that we own or exclusively license and, if a patent issues on such patent application, we could be required to obtain a license to such patent in order to carry on our business. If another party has filed a United States patent application covering an invention that is similar to, or the same as, an invention that we own or license, we or our licensors may have to participate in an interference or other proceeding in the PTO or a court to determine priority of invention in the United States for pre-AIA applications and patents. For post-AIA applications and patents, we or our licensors may have to participate in a derivation proceeding to resolve disputes relating to inventorship. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful, resulting in our inability to obtain or retain any United States patent rights with respect to such invention.

We may face intellectual property infringement claims that could be time-consuming and costly to defend and could result in our loss of significant rights and the assessment of treble damages.

We may in the future receive offers to license patents or notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. We may also initiate claims to defend our intellectual property. Intellectual property litigation, regardless of outcome, is unpredictable, expensive and time-consuming, could divert management’s attention from our business and have a material negative effect on our business, operating results or financial condition. If there is a successful claim of infringement against us, we may be required to pay substantial damages (including treble damages if we were to be found to have willfully infringed a third party’s patent) to the party claiming infringement, develop non-infringing technology, stop selling our test or using technology that contains the allegedly infringing intellectual property or enter into royalty or license agreements that may not be available on acceptable or commercially practical terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis could harm our business. In addition, revising our current or future solutions to exclude any infringing technologies would require us to re-validate the test, which would be costly and time consuming. Also, we may be unaware of pending patent applications that relate to our current or future solutions. Parties making infringement claims on future issued patents may be able to obtain an injunction that would prevent us from selling our current or future solutions or using technology that contains the allegedly infringing intellectual property, which could harm our business.

We may be required to take further action to maintain and protect our intellectual property rights against third parties.

In the event we determine that a party is infringing our intellectual property rights, we may try to negotiate a license arrangement with such party or we may determine to initiate a lawsuit against such party. The process of negotiating a license with a third party can be lengthy, and may take months or even years in some circumstances. In addition, it is possible that third parties who we believe are infringing our intellectual property rights are unwilling to license our intellectual property from us on terms we can accept, or at all.

The decision to commence litigation over infringement of a patent is complex and may lead to several risks to us, including the following, among others:

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If we are unable to protect or enforce our intellectual property rights effectively in all major markets, our business would be harmed.

Filing, prosecuting, defending and enforcing patents on all of our technologies and solutions throughout the world would be prohibitively expensive. As a result, we seek to protect our proprietary position by filing patent applications in the U.S. and in select foreign jurisdictions and cannot guarantee that we will obtain the patent protection necessary to protect our competitive position in all major markets. Competitors may use our technologies or solutions in jurisdictions where we have not obtained patent protection to develop their own products and, further, may export infringing products to territories where we have patent protection but where enforcement is not as strong as that in the U.S. These products may compete with our current and future products in jurisdictions where we do not have any issued patents, and our patent claims or other intellectual property rights may not be effective or sufficient to prevent them from so competing.

Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favor the enforcement of patents and other intellectual property protection, which could make it difficult for us to stop the infringement of our patents or the marketing of competing products in violation of our proprietary rights generally. Further, the legal systems of certain countries make it difficult or impossible to obtain patent protection for diagnostic solutions. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and could divert our efforts and attention from other aspects of our business.

If we are unable to protect the confidentiality of our trade secrets, our business and competitive position would be harmed.

In addition to seeking patents for some of our technologies and solutions, we also rely on trade secrets, including unpatented know-how, technology and other proprietary information, to maintain our competitive position. We seek to protect these trade secrets, in part, by entering into non-disclosure and confidentiality agreements with parties who have access to them, such as our employees, corporate collaborators, outside scientific collaborators, contract manufacturers, consultants, advisors and other third parties. We also enter into confidentiality and invention or patent assignment agreements with our employees and consultants that obligate them to assign to us any inventions developed in the course of their work for us. However, we cannot be certain that we have executed these agreements with each party that may have or have had access to our trade secrets or that the agreements we have executed will provide adequate protection. Despite these efforts, any of these parties may breach the agreements and disclose our proprietary information, including our trade secrets, and we may not be able to obtain adequate remedies for such breaches. Monitoring unauthorized disclosure is difficult and we do not know whether the procedures we have followed to prevent such disclosure are, or will be adequate. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret is difficult, expensive and time-consuming, and the outcome is unpredictable. In addition, some courts inside and outside the U.S. may be less willing or unwilling to protect trade secrets. If any of the technology or information that we protect as trade secrets were to be lawfully obtained or independently developed by a competitor, we would have no right to prevent them from using that technology or information to compete with us. If any of our trade secrets were to be disclosed to, or independently developed by, a competitor, our competitive position would be harmed.

If our trademarks and trade names are not adequately protected, we may not be able to build name recognition in our markets of interest, and our business may be adversely affected.

AlloMap, AlloSure, AlloSeq, Olerup SSP, Olerup XM-ONE, Olerup SBT, QTYPE and CareDx are registered trademarks of our company in the United States. Our registered or unregistered trademarks or trade names may be challenged, infringed, circumvented, declared generic or determined to be infringing on other marks. As a means to enforce our trademark rights and prevent infringement, we may be required to file trademark claims against third parties or initiate trademark opposition proceedings. This process can be expensive, particularly for a company of

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our size, and time-consuming. In addition, in an infringement proceeding, a court may decide that a trademark of ours is not valid or is unenforceable, or may refuse to stop the other party from using the trademark at issue. We may not be able to protect our rights to these and other trademarks and trade names which we need to build name recognition by potential partners or customers in our markets of interest. Over the long-term, if we are unable to establish name recognition based on our trademarks and trade names, then we may not be able to compete effectively and our business may be adversely affected.

We may be subject to claims by third parties that we or our employees have wrongfully used or disclosed alleged trade secrets or misappropriated intellectual property, or claiming ownership of what we view as our own intellectual property.

As is commonplace in our industry, we employ individuals who were previously employed at other diagnostics, medical device, life sciences or pharmaceutical companies, including our competitors or potential competitors. Although we try to ensure that our employees do not use the proprietary information of others in the course of their work for us and no claims against us are currently pending, we may be subject to claims that these employees have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. We may also be forced to bring claims against third parties or defend against third-party claims in order to determine the ownership of our intellectual property. An adverse result in the prosecution or defense of any such claims could require us to pay substantial monetary damages and could result in the loss of valuable intellectual property rights or personnel. Even if we are successful in prosecuting or defending against these claims, litigation could result in substantial costs and be a distraction to management.

Our business is dependent on licenses from third parties.

We license technology from third parties necessary to develop and commercialize our products.

In connection with our acquisition of IMX, we obtained an exclusive license from Stanford to a patent relating to the diagnosis of rejection in organ transplant recipients using dd-cfDNA. This technology is critical to AlloSure under the terms of the Stanford license, we are required to report and pay an annual license maintenance fee, six milestone payments and royalties in the low single digits on net sales of products incorporating the licensed technology. This patent has an expiration date of November 5, 2030.  A second patent included in the license from Stanford was issued in December 2017 and further covers the use of dd-cfDNA to diagnose and predict transplant status or outcome.

Our rights to use this and other licensed technologies, data and materials and to employ the inventions claimed in licensed patents are subject to the continuation of and our compliance with the terms of the applicable licenses.

Termination of the license could prevent us from producing or selling some or all of our products. Failure of a licensor to abide by the terms of a license or to prevent infringement by third parties could also harm our business and negatively impact our market position.

Risks Related to Our Common Stock

Our operating results may fluctuate, which could cause our stock price to decrease.

Fluctuations in our operating results may lead to fluctuations, including declines, in the share price for our common stock. In 2018 our stock price ranged from $5.18 to $30.02 per share. Our operating results and our share price may fluctuate from period to period due to a variety of factors, including:

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Variations in the timing of our future revenues and expenses could also cause significant fluctuations in our operating results from period to period and may result in unanticipated earning shortfalls or losses. In addition, national stock exchanges, and in particular the market for life science companies, have experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Moreover, we may be subject to additional securities class action litigation as a result of volatility in the price of our common stock, which could result in substantial costs and diversion of management’s attention and resources and could harm our stock price, business, prospects, results of operations and financial condition.

The market price of our common stock has been and will likely continue to be volatile, and you could lose all or part of your investment.

Our common stock is currently traded on the Nasdaq Global Market, but we can provide no assurances that there will be active trading on that market or on any other market in the future. If there is no active market or if the volume of trading is limited, holders of our common stock may have difficulty selling their shares. The market price of our common stock has been and may continue to be subject to wide fluctuations in response to various factors, some of which are beyond our control. In addition to the factors discussed in this “Risk Factors” section and elsewhere in this Annual Report on Form 10-K, factors that could cause fluctuations in the market price of our common stock include the following:

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If our principal stockholders, executive officers and directors choose to act together, they may be able to control our management and operations, which may prevent us from taking actions that may be favorable to you.

Our executive officers, directors and holders of 5% or more of our outstanding common stock, and entities affiliated with them, beneficially own in the aggregate approximately 15.6% of our common stock as of December 31, 2018.  These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control of us or impeding a merger or consolidation, takeover or other business combination that could be favorable to you.

Sales of substantial amounts of our common stock in the public markets, or sales of our common stock by our executive officers and directors under Rule 10b5-1 plans, could adversely affect the market price of our common stock.

We currently have effective registration statements registering shares of our common stock for resale, and such shares are currently freely tradable in the public market.  Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price that you deem appropriate. In addition, our executive officers and directors may adopt written plans, known as “Rule 10b5-1 Plans,” under which they will contract with a broker to sell shares of our common stock on a periodic basis to diversify their assets and investments. Sales made by our executive officers and directors pursuant to Rule 10b5-1, regardless of the amount of such sales, could adversely affect the market price of our common stock.

We incur costs and demands upon management as a result of complying with the laws and regulations affecting public companies in the U.S., which may adversely affect our operating results.

As a public company listed in the U.S., we incur significant additional legal, accounting and other expenses. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC and The Nasdaq Stock Market LLC may increase legal and financial compliance costs and make some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us, and our business may be harmed.

Further, if we fail to comply with these laws, regulations and standards, it might also be more difficult for us to obtain certain types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The

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impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors or as members of senior management.

If equity research analysts do not publish research or reports about our business, or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

The trading market for our common stock relies in part on the research and reports that equity research analysts publish about us and our business. We do not control these analysts or the content and opinions included in their reports. Securities analysts may elect not to provide research coverage of our common stock and a lack of research coverage may adversely affect the market price of our common stock. The price of our stock could decline if one or more equity research analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business. If one or more equity research analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

We do not expect to pay dividends in the foreseeable future. As a result, you must rely on stock appreciation for any return on your investment.

We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors. Accordingly, you will have to rely on capital appreciation, if any, to earn a return on your investment in our common stock.

If we are unable to substantially utilize our net operating loss carryforwards, our financial results could be harmed.

Section 382 of the U.S. Internal Revenue Code of 1986, as amended, generally limits the ability of a corporation that undergoes an “ownership change” to utilize its net operating loss carry-forwards, or NOLs, and certain other tax attributes against any taxable income in taxable periods after the ownership change. The amount of taxable income in each taxable year after the ownership change that may be offset by pre-change NOLs and certain other pre-change tax attributes is generally equal to the product of (a) the fair market value of the corporation’s outstanding shares (or, in the case of a foreign corporation, the fair market value of items treated as connected with the conduct of a trade or business in the United States) immediately prior to the ownership change and (b) the long-term tax exempt rate (i.e., a rate of interest established by the U.S. Internal Revenue Service, or IRS, that fluctuates from month to month). In general, an “ownership change” occurs whenever the percentage of the shares of a corporation owned, directly or indirectly, by “5-percent shareholders” (within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended) increases by more than 50 percentage points over the lowest percentage of the shares of such corporation owned, directly or indirectly, by such “5-percent shareholders” at any time over the preceding three years.  

Based on a preliminary review of our equity transactions since inception, we believe a portion of our NOLs may be limited due to the frequent equity financings that we have completed.  Utilization of our NOLs may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. Limitations imposed on our ability to utilize NOLs could cause U.S. federal and state income taxes to be paid earlier than would be paid if such limitations were not in effect and could cause such NOLs to expire unused, in each case reducing or eliminating the benefit of such NOLs. Furthermore, we may not be able to generate sufficient taxable income to utilize our NOLs before they expire. If any of these events occur, we may not derive some or all of the expected benefits from our NOLs.

Our financial controls and procedures may not be sufficient to ensure timely and reliable reporting of financial information, which could materially harm our stock price, exchange listing and our ability to finance our operations.

We are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act, or Section 404, and other requirements will increase our costs and require additional management resources. We are continuing to implement new finance and accounting systems as we grow our business and organization and to satisfy internal control and reporting requirements.

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The effectiveness of our controls and procedures may in the future be limited by a variety of factors, including:

If we are unable to complete the required Section 404 assessment as to the adequacy of our internal control over financial reporting or otherwise fail to maintain or implement effective controls and procedures for financial reporting, we could be unable to accurately and timely report our financial position, results of operations, and cash flows or key operating metrics, which could result in late filings of our annual and quarterly reports under the Securities Exchange Act of 1934, as amended, restatements of our consolidated financial statements or other corrective disclosures, a decline in our stock price, suspension or delisting of our common stock from the Nasdaq Global Market, SEC investigations, civil or criminal sanctions, an inability to access the capital and commercial lending markets, defaults under our debt and other agreements or other material adverse effects on our business, reputation, results of operations, financial condition or liquidity.

Our organizational documents and Delaware law make a takeover of our company more difficult, which may prevent certain changes in control and limit the market price of our common stock.

Our certificate of incorporation and bylaws and Section 203 of the General Corporation Law of the State of Delaware contain provisions that may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. These provisions include:

In addition, as a Delaware corporation, we are subject to Delaware law, including Section 203 of the General Corporation Law of the State of Delaware. In general, Section 203 prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder unless certain specific requirements are met as set forth in Section 203. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.

These provisions also could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some provisions in our certificate of

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incorporation and bylaws may deter third parties from acquiring us, which may limit the market price of our common stock.

We are an “emerging growth company,” and, because we are complying with certain reduced disclosure requirements applicable to emerging growth companies, our common stock could be less attractive to investors.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act, or JOBS Act, enacted in April 2012, and for as long as we continue to be an “emerging growth company,” we may continue to choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to “emerging growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We will continue to be an “emerging growth company” until the earlier of (i) the last day of the fiscal year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenue of at least $1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior September 30th, and (ii) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period. We cannot predict if investors will find our common stock less attractive as a result of our reliance on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock, and our stock price may be more volatile.

Under the JOBS Act, emerging growth companies that become public can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and therefore, we are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our headquarters are located in Brisbane, California. We lease facilities in North America, Europe, and Australia. The following is a summary of the locations, functions and approximate square footage of those facilities as of December 31, 2018:

We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities are available for lease to meet future needs.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we may become subject to legal proceedings and claims that arise in the ordinary course of business. Although we do not believe that any matters presently pending will have a material adverse effect,

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individually or in the aggregate, on our financial position, results of operations or liquidity, legal matters and proceedings are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. As such, there can be no assurance that the final outcome of these matters will not materially and adversely affect our financial position, results of operations or liquidity.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is traded on the Nasdaq Global Market under the symbol “CDNA” since July 22, 2014. The daily market activity and closing prices of our common stock can be found at www.nasdaq.com.

Holders of Record

As of March 4, 2019, there were approximately 111 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.  

Stock Performance Graph

We are a smaller reporting company, as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and are not required to provide a performance graph. 

Sales of Unregistered Securities

There were no sales of unregistered securities by us during the fourth quarter of 2018.

Securities Authorized for Issuance Under Equity Compensation Plans

See Item 12 of Part III of this Annual Report on Form 10-K regarding information about securities authorized for issuance under our equity compensation plans.

Issuer Purchases of Equity Securities

There were no repurchases of equity securities by us during the fourth quarter of 2018.

ITEM 6. SELECTED FINANCIAL DATA

The following selected historical financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The selected balance sheet data at December 31, 2018 and 2017 and the selected statements of operations data for each of the years ended December 31, 2018, 2017 and 2016 have been derived from our audited consolidated financial statements that are included elsewhere in this Annual Report on Form 10-K. The financial data included in this report are historical and are not necessarily indicative of results to be expected in any future period.

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Statements of Operations Data:

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Balance Sheet Data:  

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains certain forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those set forth under the Section entitled “Risk Factors” in Item 1A, and other documents we file with the Securities and Exchange Commission. Historical results are not necessarily indicative of future results.

Overview and Recent Highlights

We are a global transplant diagnostics company with product and service offerings along the pre- and post-transplant continuum.  We focus on discovery, development and commercialization of clinically differentiated, high-value diagnostic solutions for transplant patients.

Testing Services

AlloMap

Our first commercialized testing solution, the AlloMap heart transplant molecular test, or AlloMap, is a gene expression test that helps clinicians monitor and identify heart transplant recipients with stable graft function who have a low probability of moderate-to-severe acute cellular rejection.  Since 2008, we have sought to expand the adoption and utilization of our AlloMap solution through ongoing studies to substantiate the clinical utility and actionability of AlloMap, secure positive reimbursement decisions for AlloMap from large private and public payers, develop and enhance our relationships with key members of the transplant community, including opinion leaders at major transplant centers, and explore opportunities and technologies for the development of additional solutions for post-transplant surveillance.  We believe the use of AlloMap, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a heart transplant. In particular, we believe AlloMap can improve patient care by helping healthcare providers avoid the use of unnecessary, invasive surveillance biopsies and determine the appropriate dosage levels of immunosuppressants.  In 2008, AlloMap received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, for marketing and sale as a test to aid in the identification of recipients with a low probability of moderate or severe acute cellular rejection.

AlloMap has received positive coverage decisions for reimbursement from Medicare.  The 2018 reimbursement rate for AlloMap was $3,240, which represented a 14% increase over the 2017 reimbursement rate.  AlloMap has also received positive coverage decisions for reimbursement from many of the largest U.S. private payers, including Aetna, Anthem, Cigna, Health Care Services Corporation (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE and UnitedHealthcare.  

We have also successfully completed a number of landmark clinical trials in the transplant field demonstrating the clinical utility of AlloMap for surveillance of heart transplant recipients.  We initially established the analytical and clinical validity of AlloMap on the basis of our Cardiac Allograft Rejection Gene Expression Observational (Deng, M. et al., Am J Transplantation 2006), or CARGO, study, which was published in the American Journal of Transplantation. A subsequent clinical utility trial, Invasive Monitoring Attenuation through Gene Expression (Pham MX et al., N. Eng. J. Med., 2010), or IMAGE, published in The New England Journal of Medicine, demonstrated that clinical outcomes in recipients managed with AlloMap surveillance were equivalent (non-inferior) to outcomes in recipients managed with biopsies.  The results of our clinical trials have also been presented at major medical society congresses.

Since the launch of AlloMap in January 2005, we have performed more than 123,000 commercial AlloMap tests, including 16,116 tests during 2018.  During the year ended December 31, 2018, AlloMap was used in 133 of the approximately 138 heart transplant centers in the United States.  

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AlloSure

AlloSure, our transplant surveillance solution which was commercially launched in October 2017, applies proprietary next generation sequencing technology to measure donor-derived cell-free DNA, or dd-cfDNA, in the blood stream emanating from the donor kidney.  We believe AlloSure may help clinicians determine rejection-specific activity manifested as cell damage in the transplanted heart, kidney, or other solid organ, irrespective of the type of organ transplanted.  We also believe the use of AlloSure, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a kidney transplant. In particular, we believe AlloSure can improve patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants. Effective October 9, 2017, AlloSure became available for commercial testing with Medicare coverage and reimbursement. The Medicare reimbursement rate for AlloSure is $2,841. AlloSure has also received payment from private payers on a case-by-case basis, but no positive coverage decisions have been made to the date of this filing.

Prior to the commercialization of AlloSure, we generated a strong body of clinical evidence.  In late 2015, we announced the completion of analytical validation of AlloSure.  A report describing the analytical validation of AlloSure including clinical validation detailing the quality, reality and consistency of analytical results information for heart transplant, appeared in the November 2016 issue of The Journal of Molecular Diagnostics.  The Circulating Donor-Derived Cell-Free DNA in Blood for Diagnosing Acute Rejection in Kidney Transplant Recipients, or DART, trial, sponsored by us, was conducted between April 2015 and January 2018.  DART is a 14 center observational study of kidney transplant recipients where blood specimens are drawn periodically after transplant during follow up visits and also after treatment for acute rejection.  By the time of completion of the first analysis, 384 patients were followed in DART for up to 24 months.  The results demonstrated that increased levels of dd-cfDNA, determined by the AlloSure assay, discriminated active rejection of a kidney transplant more effectively than serum creatinine values. In collaboration with clinical investigators, we published these findings in the scientific peer-reviewed Journal of the American Society of Nephrology and the Journal Applied Laboratory Medicine in March 2017. A total of 2,109 patient visits had been accrued in DART by January 2019. We plan to analyze and report on additional findings from this dataset in 2019 and into the future.

In 2018, we initiated the Kidney Allograft Outcomes AlloSure Registry, or K-OAR study, to develop further data on the clinical utility of AlloSure for surveillance of kidney transplant recipients.  As of December 31, 2018, 47 centers have been initiated as K-OAR study sites.

During the year 2018, there were 11,634 AlloSure patient test results provided.  In the fourth quarter of 2018, AlloSure was ordered by 100 kidney transplant centers in the United States.

HeartCare

In September, 2018, we initiated the Surveillance HeartCare Outcomes Registry (“SHORE”). SHORE is a prospective, multi-center, observational, registry of patients receiving HeartCare for surveillance.

HeartCare combines the gene expression profiling technology of AlloMap with the dd-cfDNA analysis of AlloSure-Heart in one surveillance solution. An approach to surveillance using HeartCare provides information from the two complementary measures: (i) AlloMap – a measure of immune activation, and (ii) AlloSure-Heart® – measures graft injury. HeartCare provides complementary information about distinct biological processes, such as immune quiescence, active injury, Acute Cellular Rejection (“ACR”) and Antibody Mediated Rejection (“AMR”) in heart transplant recipients.

Products

We develop, manufacture, market and sell products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs. We also help clinicians manage transplant patients after the transplant has occurred.

QTYPE enables speed and precision in HLA typing at a low to intermediate resolution for samples that require a fast turn-around-time and uses real-time polymerase chain reaction, or PCR, methodology. QTYPE received CE mark

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certification on April 10, 2018. Olerup SSP is used to type Human Leukocyte Antigen, or HLA alleles, based on the sequence specific primer, or SSP technology.  Olerup SBT is a complete product range for sequence-based typing of HLA alleles.  

On May 4, 2018, we entered into a License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina’s NGS product line for use in transplantation diagnostic testing.

As a result, on June 1, 2018, we became the exclusive worldwide distributor of Illumina’s TruSight HLA product line. TruSight HLA is high resolution solution that uses NGS methodology. In addition, we were granted the exclusive right to develop and commercialize other NGS product lines for use in the field of bone marrow and solid organ transplantation diagnostic testing.

Fourth Quarter 2018 Highlights

Financial Operations Overview

Revenue

We derive our revenue from testing services, products sales and license and other revenues. On January 1, 2018, we adopted the new revenue accounting standard Revenue from Contracts with Customers (Topic 606), or ASC 606, using the modified retrospective method. Under the new accounting standard, revenue is recorded considering a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations and recognizing revenue when, or as, an entity satisfies a performance obligation. The adoption of ASC 606 resulted in a one-time adjustment of $2.9 million to accounts receivable and accumulated deficit.  This adjustment reflected the estimated payments to be received for tests where the result had been delivered at December 31, 2017, but the associated revenue had not been recognized by December 31, 2017, because payments had not been received. As of December 31, 2018, we had received payments of $3.4 million for these tests and recorded a change in estimate of $0.5 million as additional testing services revenue during 2018 year. Adoption of ASC 606 did not have any impact on product and license revenue recognized in prior periods.

Testing Services Revenue

Our testing services revenue is derived from AlloMap and AlloSure tests, which represented 79%, 69% and 73% of our total revenues for the years ended December 31, 2018, 2017 and 2016, respectively. Our testing services revenue depends on a number of factors, including (i) the number of tests performed; (ii) establishment of coverage policies by third-party insurers and government payers; (iii) our ability to collect from payers with whom we do not have positive coverage determination, which often requires that we pursue a case-by-case appeals process; (iv) our ability to recognize revenues on tests billed prior to the establishment of reimbursement policies, contracts or payment

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histories; (v) our ability to expand into markets outside of the United States; and (vi) how quickly we can successfully commercialize new product offerings.

We currently market testing services to healthcare providers through our direct sales force that targets transplant centers and their physicians, coordinators and nurse practitioners.  The healthcare providers that order the tests and on whose behalf we provide our testing services are generally not responsible for the payment of these services.  Amounts received by us vary from payer to payer based on each payer’s internal coverage practices and policies.  We generally bill third-party payers upon delivery of a test result report to the ordering physician. As such, we take the assignment of benefits and the risk of collection from the third-party payer and individual patients.

During 2018 we performed 16,116 commercial AlloMap tests that are included in our estimated testing revenue. We also recognized additional $0.5 million in revenue related to tests performed in prior period due to the change in estimated transaction price in accordance with new revenue recognition standard ASC 606.

Since October 2017, when we launched AlloSure, we performed 282 commercial AlloSure tests as of December 31, 2017. During 2018 we performed 11,634 commercial AlloSure tests. All tests were performed from our Brisbane, California laboratory.

Product Revenue

Our product revenue is derived primarily from sales of Olerup SSP, QTYPE, Olerup SBT and TruSight products. Product revenue represented 20%, 30% and 26% of total revenue for the years ended December 31, 2018, 2017 and 2016, respectively. We recognize product revenue from the sale of products to end-users, distributors and strategic partners when all revenue recognition criteria are satisfied.  We generally have a contract or a purchase order from a customer with the specified required terms of order, including the number of products ordered. Transaction prices are determinable and products are delivered and risk of loss passed to the customer upon either shipping or delivery, as per the terms of the agreement. There are no further performance obligations related to a contract and revenue is recognized at the point of delivery consistent with the terms of the contract or purchase order.

License and Other Revenue

License agreements may include non-refundable upfront payments, partial or complete reimbursement of research and development costs, contingent payments based on the occurrence of specified events under the agreements, license fees and royalties on sales of products or product candidates if they are successfully commercialized. Our performance obligations under the collaboration and license agreements may include the transfer of intellectual property rights in the form of licenses, obligations to provide research and development services and obligations to participate on certain development committees with the collaboration partners. We make judgments that affect the periods over which we recognize revenue. We review our estimated periods of performance based on the progress under each arrangement and account for the impact of any change in estimated revenues.

Segment Reporting

We changed our segment reporting from two reportable segments: Post-Transplant and Pre-Transplant to one reportable segment. In the third quarter of 2018, we completed a business reorganization to support our strategy to become a global transplant care leader. The position of the head of the former Pre-Transplant segment was eliminated, and global functional leaders were identified to manage sales and marketing, research and development, manufacturing and quality and other global functions. These changes resulted in changes to the presentation of financial information provided to our chief operating decision maker (the “CODM”), who is our chief executive officer, for resource allocation and management performance assessment. The CODM continues to review revenue and cost of sales by testing services and products, as reported in the consolidated statements of operations. Earnings before interests, tax, depreciation and amortization, and operating results are reviewed at the consolidated level only. Effective September 30, 2018, we report a single operating segment.

Goodwill Impairment

We test goodwill and indefinite-lived intangibles for impairment at least annually and more frequently if impairment indicators are present. We recorded goodwill impairment charges related to our former Pre-Transplant reporting unit

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of $13.0 million and $2.0 million as of December 31, 2016 and March 31, 2017, respectively. Goodwill allocated to our former Pre-Transplant reporting unit was fully impaired at March 31, 2017. The remaining goodwill of $12.0 million relates to our former Post-Transplant reporting unit and it was not impaired. No impairment charges were recorded in 2018.

Change in Estimated Fair Value of Contingent Consideration

We revalued our contingent consideration obligation liability in connection with our acquisition of IMX in 2014 at the end of each reporting period through the settlement date.  Changes in the fair value of our contingent consideration obligation were recognized as a component of operating expense within our consolidated statements of operations.  We achieved the contingent consideration obligation milestone of 2,500 commercial AlloSure tests and issued 227,848 shares of our common stock in the three month period ended June 30, 2018.  We recorded $1.0 million expense related to changes in fair value of contingent consideration from January 1, 2018 to the date of the shares issuance. There is no contingent consideration obligation outstanding as of December 31, 2018.

Debt Extinguishment Expenses

In connection with the repayment and conversion to shares of common stock of all outstanding debt obligations during 2018, we recorded $2.8 million loss on the conversion of the convertible debt financing with JGB (the “JGB Debt”) as the difference between the value of the shares of common stock issued on the days of conversion and the amount of principal debt converted on those days, net of the allocated debt discount and derivative liability balances. During the same period we also recorded a $3.0 million loss on debt extinguishment of the credit agreement with Perceptive Credit Holdings II, LP, or Perceptive, or the Perceptive Credit Agreement.

Other Expense, Net

Other expense includes gains and losses on foreign currency transactions and other miscellaneous expenses. During the year ended December 31, 2018, the other expense charge of $0.2 million primarily consisted franchise taxes paid.

Change in Estimated Fair Value of Common Stock Warrant and Derivative Liabilities

We recorded $23.0 related to changes in fair value of common stock warrants and derivative liabilities, as these financial instruments are classified in liabilities during the year ended December 31, 2018. Common stock warrants issued in connection with our debt and equity financings are considered freestanding financial instruments and are analyzed as to whether they meet equity or liability classification in accordance with United States generally accepted accounting principles, or US GAAP. Warrants that meet liability classification are remeasured at each period end with changes in fair value recorded in our consolidated statements of operations until these warrants are exercised or expire. On January 1, 2018, we adopted Accounting Standards Update No. 2017-11, Accounting for Certain Financial Instruments with Down Round Features and Replacement of the Indefinite Deferral of Mandatorily Redeemable Financial Instruments of Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception, and this resulted in the liability balance for our warrants issued to JGB being reclassified to equity on the date of adoption.  

The JGB Debt included certain embedded derivatives that required bifurcation, including settlement and penalty provisions.  The embedded derivative was remeasured at each reporting period with changes recorded in change in estimated fair value of common stock warrant liability and derivative liability in the consolidated statements of operations.  As of March 27, 2018, the JGB Debt was fully converted to shares of our common stock and the derivative was extinguished.  

On April 17, 2018, we entered into the Perceptive Credit Agreement for an initial term loan of $15.0 million, which included an embedded derivative that required bifurcation related to early repayment provision.  We recorded changes in the fair value of the derivative liabilities in the change in estimated value of common stock warrant liability and derivative liability in our consolidated statements of operations. All amounts owing under the Perceptive Credit Agreement were fully paid off on November 20, 2018 and the derivative was extinguished.  

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Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. Some of these accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We believe that the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize revenue from testing services, products and license and other revenue in the amount that reflects the consideration which it expects to be entitled in exchange for goods or services as it transfers control to its customers.  Revenue is recorded considering a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation.

Testing Services Revenue

Patient tests are ordered by healthcare providers.  We receive a test requisition form with payer information along with a collected patient blood sample. We consider the patient to be our customer and the test requisition form a contract. Testing services are performed in our laboratory. Testing services represent one performance obligation in a contract and are performed when results of the test are provided to the healthcare provider, at a point of time.

The healthcare providers that order the tests and on whose behalf we provide testing services are generally not responsible for the payment of these services.  The first and second revenue recognition criteria are satisfied when we receive a test requisition form with payer information from the healthcare provider.  Generally, we bill third-party payers upon delivery of test result to the healthcare provider. Amounts received may vary amongst payers based on coverage practices and policies of the payer.  We determine an estimate of a transaction price by financial class of payers. Transaction prices are determined for each financial class using history of reimbursements, including analysis of an average reimbursement per test and a percentage of tests reimbursed. We estimate revenue for non-contracted payers and self-payers using this methodology.  The estimate requires significant judgment. Revenue recognized for Medicare and other contracted payers is based on the agreed current reimbursement rate per test, adjusted for historical collection trends where applicable.

The process for determining the appropriate transaction price involves judgment, and considers such factors as, historical payment trends, current economic conditions and regulatory changes. The ultimate amounts of collections could be different from the amounts we estimate.

During 2018, we recognized $0.5 million additional revenue related to the change in estimate of reimbursement of testing services as we collected more than we estimated for tests performed in prior year.

Product Revenue

Product revenue is recognized from the sale of products to end-users, distributors and strategic partners when all revenue recognition criteria are satisfied.  We generally have a contract or a purchase order from a customer with the specified required terms of order, including the number of products ordered. Transaction prices are determinable and products are delivered and risk of loss passed to the customer upon either shipping or delivery, as per the terms of

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the agreement. There are no further performance obligations related to a contract and revenue is recognized at the point of delivery consistent with the terms of the contract or purchase order.

License and Other Revenue

We generate revenue from license agreements.  License agreements may include non-refundable upfront payments, partial or complete reimbursement of research and development costs, contingent payments based on the occurrence of specified events under the agreements, license fees and royalties on sales of products or product candidates if they are successfully commercialized.  Our performance obligations under the agreements may include the transfer of intellectual property rights in the form of licenses, obligations to provide research and development services and obligations to participate on certain development committees.  We make judgments to determine if performance obligations are distinct or should be combined and the transaction price allocated to each performance obligation, which affect the periods over which revenue is recognized.  We periodically review our estimated periods of performance based on the progress under each arrangement and accounts for the impact of any change in estimated periods of performance on a prospective basis. We constrain variable consideration, such as milestones, if it is probable that a significant portion of revenue would be reversed. Our deferred revenue relates to one performance obligation, which should be recognized over time.

We did not recognize any revenue connected with milestones during the twelve months ended December 31, 2018 or 2017.

Business Combinations

In accordance with ASC Topic 805, Business Combinations, we determine and allocate the purchase price of an acquired business to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the business combination date, including identifiable intangible assets that either arise from a contractual or legal right or are separable from goodwill. We base the estimated fair value of identifiable intangible assets acquired in a business combination on independent valuations that use information and assumptions provided by management, which consider management’s best estimates of inputs and assumptions that a market participant would use.

We allocate any excess purchase price over the estimated fair value assigned to the net tangible and identifiable intangible assets acquired and liabilities assumed to goodwill. The use of alternative valuation assumptions, including estimated revenue projections, growth rates, royalty rates, cash flows, discount rates, estimated useful lives and probabilities surrounding the achievement of contingent milestones, could result in different purchase price allocations and amortization expense in current and future periods.

In those circumstances where an acquisition involves a contingent consideration arrangement that meets the definition of a liability under ASC Topic 480, Distinguishing Liabilities from Equity, we recognize a liability equal to the fair value of the contingent payments we expect to make as of the acquisition date. We remeasured this liability each reporting period and record changes in the fair value as a component of operating expenses.

Transaction costs associated with acquisitions are expensed as incurred in general and administrative expenses. Results of operations and cash flows of acquired companies are included in our operating results from the date of acquisition.

Acquired Intangible Assets

Amortizable intangible assets may include customer relationships, developed technology, trademarks, contracts and acquired in-process technology assets as part of a business combination.  Intangible assets subject to amortization are amortized over their estimated useful lives. Acquired in-process technology assets are considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts.  If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed finite-lived and would then be amortized based on their respective estimated useful lives at that point in time.

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Impairment of Goodwill, Intangible Assets and Long-lived Assets

Goodwill

Goodwill recorded in a business combination is not subject to amortization. Instead, it is tested for impairment on an annual basis and whenever events or changes in circumstances indicate its carrying amount may not be recoverable.

Our annual impairment test date is December 1^st. A qualitative assessment is initially made to determine whether it is necessary to perform a quantitative assessment. A qualitative assessment includes, among others, consideration of: (i) past, current and projected future earnings; (ii) recent trends and market conditions; and (iii) valuation metrics involving similar companies that are publicly-traded and acquisitions of similar companies, if available. If this qualitative assessment indicates that it is more likely than not that an impairment exists, or if we decides to bypass this option, it proceeds to the quantitative assessment. The quantitative assessment consists of a comparison between the estimated fair value of our reporting unit and its respective carrying amount including goodwill. Where the carrying value of the reporting unit exceeds its estimated fair value, we will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit.

When necessary, to determine the reporting unit’s fair value under the quantitative approach, we use a combination of income and market approaches, such as estimated discounted future cash flows of that reporting unit, multiples of earnings or revenues, and analysis of recent sales or offerings of comparable entities. We also consider our market capitalization on the date of the analysis to ensure the reasonableness of the reporting unit’s fair value.

In the third quarter of 2018, we changed our segments and reporting units. During that period, we determined that we operate in one reportable segment. Prior to September 30, 2018 we had two reporting units – Post and Pre-transplant.  We recorded goodwill impairment charges of $13.0 million and $2.0 million for the periods ended December 31, 2016 and December 31, 2017, respectively. The impairment charges resulted in full impairment of goodwill related to our former Pre-transplant reporting unit as of March 31, 2017.  No goodwill impairment related to former Post-transplant reporting unit was recorded in prior periods.  See Note 6 for additional discussion regarding the impairment charge recorded.

In connection with our annual goodwill assessment on December 1, 2018, we performed a qualitative assessment at the consolidated level taking into consideration past, current and projected future earnings, recent trends and market conditions; and its market capitalization. Based on this analysis, we concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying amount. As such, it was not necessary to perform the quantitative goodwill impairment assessment at that time. As of December 31, 2018, no impairment of goodwill has been identified.

Intangible assets not subject to amortization

We evaluate the carrying value of intangible assets not subject to amortization, related to acquired in-process technology assets, which are considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts. Accordingly, amortization of the acquired in-process technology assets will not occur until the products reach commercialization. During the period the assets are considered indefinite-lived, they are tested for impairment on an annual basis, as well as between annual tests if we become aware of any events occurring or changes in circumstances that would indicate that the fair values of the acquired in-process technology assets are less than their carrying amounts. An impairment loss would be recorded when the fair value of an acquired in-process technology asset is less than its carrying value. If and when development is complete, which generally occurs when the products are made commercially available, the associated acquired in-process technology asset will be deemed finite-lived and will then be amortized based on its estimated useful life.

Intangible assets and long-lived assets subject to amortization

We evaluate our finite-lived intangible assets and our long-lived assets for indicators of possible impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  We then compare the carrying amounts of the assets with the future net undiscounted cash flows expected to be generated by such asset. If an impairment exists, we measure the impairment based on the excess carrying value of the asset over the asset’s fair value determined using discounted estimates of future cash flows. We have not identified any such impairment losses to date.

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Common Stock Warrant Liability

Common stock warrants issued with debt, equity or as standalone financing instruments are recorded as either liabilities or equity in accordance with the respective accounting guidance. Warrants recorded as equity are recorded at their relative fair value determined at the issuance date and are not remeasured after that. Warrants recorded as liabilities are recorded at their fair value and remeasured on each reporting date with changes recorded in change in estimated fair value of common stock warrant liability and derivative liability in the consolidated statements of operations.

We utilize a binomial-lattice pricing model (the “Monte Carlo Simulation Model”) that involves a market condition simulation to estimate the fair value of the warrants.  The application of the Monte Carlo Simulation Model requires the use of a number of complex assumptions including our stock price, expected life of the warrants, stock price volatility determined from the our historical stock prices and stock prices of peer companies in the diagnostics industry, and risk-free rates based on the implied yield currently available in the U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the warrants.  Increases (decreases) in these assumptions result in a directionally similar impact to the fair value of the common stock warrant liability. Refer to Note 4 of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for key assumptions used to value outstanding warrant liability.

Derivative Liability

The JGB Debt included certain embedded derivatives that required bifurcation, including settlement and penalty provisions.  The combined embedded derivative liability was remeasured on a quarterly basis with changes recorded in change in estimated fair value of common stock warrant liability and derivative liability in the consolidated statements of operations.  We utilize a Monte Carlo simulation model to estimate the fair value of our embedded derivative liability.  The Monte Carlo simulation model uses multiple input assumptions to simulate the likelihood that market conditions will be achieved through 100,000 random trials.  These assumptions included the expected term of the embedded derivative, the volatility of our stock prices and our peers’ stock prices over such expected term, likelihood, timing, and amount of future equity financing rounds, the likelihood of any prepayment or default events, the likelihood of monthly redemptions by the JGB Debt holders and the likelihood and ability of JGB to convert the debt into equity.  In each iteration of the simulations, these assumptions were used to simulate our stock price drawing from a risk neutral distribution, the occurrence of a conversion event, the occurrence of a prepayment event, the occurrence of a default event, and any resulting payoff from such event.  The average present value over all iterations of the simulation was then calculated.  The assumptions used in this simulation model were reviewed on a quarterly basis and adjusted, as needed.

As of March 27, 2018, the JGB Debt was fully converted to shares of our common stock.  The change in the fair market value of the derivative liability through March 27, 2018 of $2.5 million was recorded in change in estimated fair value of common stock warrant liability and derivative liability in the consolidated statements of operations.

In April, 2018, we entered into the Perceptive Credit Agreement, which included an embedded derivative related to early repayment provisions that required bifurcation. This embedded derivative of $0.2 million was extinguished in November 2018, when the outstanding debt was fully paid off.

Recently Issued Accounting Standards

Refer to Note 2, Summary of Significant Accounting Policies - Recent Accounting Pronouncements, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a description of recently issued accounting pronouncements, including the expected dates of adoption and estimated effects on our results of operations, financial position and cash flows.

Factors Affecting Our Performance

The Number of AlloMap and AlloSure Tests We Receive and Report

The growth of our testing services business is tied to the number of AlloMap and AlloSure patient samples we receive and patient results we report. Historically, less than two percent of AlloMap patient samples received are not

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reported due to improper sampling, damage in transit or other causes. We incur costs in connection with collecting and shipping all samples and a portion of the costs when we cannot ultimately issue a report. As a result, the number of patient samples received largely correlates directly to the number of patient results reported.

The Number of Diagnostic Products We Sell

The growth of our product revenues is tied to the sales of the Olerup SSP, QTYPE, Olerup SBT and TruSight HLA product lines.  The product sales organizations are located in Stockholm, Sweden; Vienna, Austria; Fremantle, Australia and West Chester, Pennsylvania.  Products are sold directly to customers in 14 countries. We also use distributors to sell products in approximately 60 countries.  

Continued Adoption of and Reimbursement for AlloMap

AlloMap test volume and the corresponding reimbursement revenue has generally increased over time since the launch of AlloMap, as Medicare provided reimbursement and payers adopt coverage policies and fewer payers consider AlloMap to be experimental and investigational.  The rate at which our tests are covered and reimbursed has, and is expected to continue to vary by payer.  Revenue growth depends on our ability to maintain Medicare reimbursement, achieve broader reimbursement from third party payers and to expand the number of tests per patient and the base of healthcare providers.

The Protecting Access to Medicare Act of 2014, or PAMA, includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS would report initially and then on a subsequent three-year basis thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests.  The final PAMA ruling was issued June 17, 2016 indicating that data for reporting for the new PAMA process would begin in 2017 and the new market based rates took effect on January 1, 2018.  Effective January 1, 2018, Medicare reimburses us $3,240 for AlloMap testing of Medicare beneficiaries, and increase from the 2017 reimbursement rate of $2,840.  AlloMap has also received positive coverage decisions for reimbursement from many of the largest U.S. private payers, including Aetna, Anthem, Cigna, Health Care Services Corporation (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE and UnitedHealthcare.

Reimbursement for AlloSure

On September 26, 2017 we received notice that the Molecular Diagnostics Services, or MolDX, Program developed by Palmetto had set AlloSure reimbursement at $2,841.  Effective October 9, 2017, AlloSure was made available for commercial testing with Medicare coverage and reimbursement. We believe the use of AlloSure, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a kidney transplant. In particular, we believe AlloSure can improve patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants.  

Continued Growth of Product Sales

We develop, manufacture, market and sell products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs. Olerup SSP is used to type Human Leukocyte Antigen, or HLA, alleles based on sequence-specific primer, or SSP, technology.  Olerup SBT is a complete product range for sequence-based typing of HLA alleles. QTYPE enables speed and precision in HLA typing at a low to intermediate resolution for samples that require a fast turn-around time and uses real-time polymerase chain reaction, or PCR, methodology.  QTYPE received CE mark certification on April 10, 2018.

In May 2018, we entered into a License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina’s next generation sequencing (“NGS”) product line for use in transplantation diagnostic testing. As a result, from June 1, 2018, we are the exclusive worldwide distributor of Illumina’s TruSight HLA v1 and v2 product line. In addition, we were also granted the exclusive right to develop and commercialize other NGS product lines for use in the Field, as defined in the agreement.

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Development of Additional Products

We rely on sales of AlloMap, AlloSure, Olerup SSP, Olerup SBT, QTYPE and TruSight HLA to generate the majority of our revenue.  Our development pipeline includes other transplant diagnostic solutions to help clinicians and transplant centers make personalized treatment decisions throughout a transplant patient’s lifetime.  We expect to invest in research and development in order to develop additional products.  Our success in developing new products and services will be important in our efforts to grow our business by expanding the potential market for our products and diversifying our sources of revenue.

Timing of Research and Development Expenses

Our spending on research and development may vary substantially from quarter to quarter.  We also expend funds to secure clinical samples that can be used in discovery, product development, clinical validation, utility and outcome studies.  The timing of these research and development activities is difficult to predict.  If a substantial number of clinical samples are acquired in a given quarter or if a high-cost experiment is conducted in one quarter versus the next, the timing of these expenses will affect our financial results.  We conduct clinical studies to validate our new products, as well as on-going clinical and outcome studies to further the published evidence to support our commercialized tests.  Spending on research and development for both experiments and studies may vary significantly by quarter depending on the timing of these various expenses.

Results of Operations

Comparison of the Years Ended December 31, 2018 and 2017

(In thousands)

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 Testing Services Revenue

Testing services revenue increased by $27.2 million, or 82%, for the year ended December 31, 2018, compared to the same period in 2017.  This increase is mainly due to the 11,634 AlloSure test results provided in the year ended December 31, 2018, compared to 282 AlloSure tests provided in the year ended December 31, 2017 following the commercial launch of AlloSure in October 2017. Additionally, AlloMap test results increased to 16,116 in the year ended December 31, 2018, compared to 15,312 in the same period in 2017, and the Medicare reimbursement rate for AlloMap increased from $2,841 to $3,240 on January 1, 2018. Furthermore, in the year ended December 31, 2018, we recognized $0.5 million testing services revenue related to payments received in excess of the $2.9 million accounts receivable adjustment recorded on January 1, 2018 upon adoption of the new revenue recognition standard, ASC 606.

Furthermore, the adoption of the new revenue standard had a $1.6 million favorable impact on our Testing Revenue, as compared to the revenue that would have been recognized under the prior guidance for the year ended December 31, 2018.

Product Revenue

Product revenue increased by $1.0 million, or 7%, for the year ended December 31, 2018, compared to the same period in 2017. The increase was due to sales of the TruSight HLA products related to the License Agreement with Illumina, which was signed in May 2018, and increased sales of QTYPE, partially offset by a decrease in sales of Olerup SSP and Olerup SBT products.

License and Other Revenue

License and other revenue increased by less than $0.1 million for the year ended December 31, 2018.

Cost of Testing Services

Cost of testing increased by approximately $9.1 million, or 74%, for the year ended December 31, 2018, compared to the same period in 2017, primarily due to the increase in test results provided for AlloSure, which was launched in October 2017, and AlloMap.

Cost of Product

Cost of product increased by $2.5 million, or 28%, for the year ended December 31, 2018, compared to the same period in 2017. The increase in revenue, a change in the mix of products, and the addition of sales of TruSight HLA products, which were purchased directly from Illumina, led to an increase of $2.1 million. Furthermore, in the year ended December 31, 2018 there was an increase in scrap and obsolescence provision of $0.4 million.  

Research and Development

Research and development expenses increased by $2.1 million, or 17%, for the year ended December 31, 2018, compared to the same period in 2017.  This increase is primarily due to an increase of $0.9 million in stock-based compensation expense, an increase of $0.6 million in clinical trial costs, an increase of $0.5 million in personnel costs, and an increase of $0.1 million in consulting and professional fees.

Sales and Marketing

Sales and marketing expenses increased by approximately $8.9 million, or 69%, for year ended December 31, 2018, compared to the same period in 2017, primarily due to an increase in personnel related expenses of $4.3 million, higher conference fees and travel costs of $2.0 million associated with several key transplant industry events, increased stock-based compensation expenses of $0.8 million, higher consulting and professional fees of $0.7 million, and higher marketing related costs of $0.4 million.

General and Administrative

General and administrative expenses increased by $3.0 million, or 16%, for the year ended December 31, 2018, compared to the same period in 2017.  This primarily reflects an increase of $2.7 million in stock-based compensation expense, an increase of $1.8 million in personnel related expenses, higher travel expenses of $0.2

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million, and higher facilities and software related costs of $0.2 million, partially offset by a decrease in consulting and professional fees of $1.6 million, and a decrease in audit fees of $0.8 million.

Goodwill Impairment

In the three months ended March 31, 2017, we determined that the decrease in our market capitalization constituted an indicator of impairment and therefore a goodwill impairment test was completed as of March 31, 2017.  We recorded a goodwill impairment charge of $2.0 million and wrote off the remaining goodwill in the former Pre-Transplant reporting unit as of March 31, 2017. No impairment was identified in the year ended December 31, 2018.

Change in Estimated Fair Value of Contingent Consideration

In accordance with the IMX acquisition agreement, we estimated the contingent consideration liability fair value at each period end based on our common stock price at the end of the period and a probability of meeting the contractual milestone related to the number of commercial tests performed by June 2020. The contingent consideration liability was settled in the six months ended June 30, 2018, with the achievement of the contractual milestone of 2,500 commercial AlloSure tests. Changes in fair value of the contingent liability were $1.0 million expense and $1.2 million expense for the years ended December 31, 2018 and 2017 respectively. The $1.0 million expense reflected an increase in our share price from January 1, 2018 to the date of the issuance of the 227,848 shares and settlement of the liability.  The $1.2 million expense reflected an increase in our share price in the year ended December 31, 2017 and an increase in our estimate of the probability of meeting the milestone under our business combination agreement with IMX.

Interest Expense, Net

Interest expense decreased by $2.2 million for the year ended December 31, 2018, compared to the same period in 2017.

The interest expense of $3.7 million in the year ended December 31, 2018, consisted of $2.5 million of interest expense and debt discount amortization related to the JGB Debt, $1.2 million of interest expense and debt amortization recorded in relation to the Perceptive Credit Agreement entered into on April 17, 2018 and $0.2 million of interest expense recorded in relation to the Allenex Notes, the Danske Bank Term Loan and the SSP Primers Loan. These interest expense amounts were partially offset by interest income of $0.2 million earned on cash and cash equivalent balances.

The interest expense of $5.9 million in the year ended December 31, 2017, consisted of $4.2 million of interest expense and debt discount amortization related to the JGB Debt, $0.6 million of interest expense recorded in relation to deferred purchase consideration owed to the former shareholders of Allenex, $0.9 million in interest expense recorded on the Allenex Notes, the Danske Bank Term Loan and the SSP Primers Loan and $0.2 million of interest expense recorded on the East West Bank Debt.

The JGB Debt was entered into on March 15, 2017 and during the three months ended March 31, 2018 was converted into shares of our common stock. The deferred purchase consideration was related to the acquisition of Allenex and was settled in November 2017. The SSP Primers Loan was repaid in February 2018 and the Allenex Notes and Danske Bank Term Loan were repaid in April 2018. The outstanding indebtedness under the East West Bank Debt was repaid in March 2017. On April 17, 2018, we entered into the Perceptive Credit Agreement for an initial term loan of $15.0 million. The obligations under the Perceptive Credit Agreement were fully repaid on November 20, 2018.

Debt Extinguishment Expenses

Debt extinguishment expenses increased by $5.3 million in the year ended December 31, 2018 compared to the same period in 2017.  In the year ended December 31, 2018, debt extinguishment expenses of $5.8 million consisted of a loss of $2.8 million on the conversion of the JGB Debt in the three months ended March 31, 2018 and a $3.0 million loss on the debt extinguishment of the Perceptive Credit Agreement. In the year ended December 31, 2017,

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debt extinguishment expenses of $0.5 million consisted of a $0.3 million loss on a $1.2 million conversion of JGB debt and $0.2 million of debt extinguishment fees on East West Bank debt.

Other Expense, Net

Other expense decreased by $0.8 million in the year ended December 31, 2018, compared to the same period in 2017.  In the year ended December 31, 2018, the other expense charge of $0.2 million primarily consisted franchise taxes paid.  In the year ended December 31, 2017, the other expense charge of $1.0 million consisted mainly of a foreign exchange loss of $0.6 million, $0.2 million for franchise taxes and $0.2 million in JGB Debt issuance costs.

Change in Estimated Fair Value of Common Stock Warrant and Derivative Liabilities

The change in estimated fair value of common stock warrant liability and derivative liability was $23.0 million expense in the year ended December 31, 2018 and $29.6 million expense in 2017.

The $23.0 million expense in the year ended December 31, 2018, consisted of a remeasurement charge of $25.6 million related to the changes in fair value of common stock warrant liability, partially offset by a $2.6 million gain recorded for the changes in fair value of the JGB Debt embedded derivative between January 1, 2018 and the debt conversion date of March 27, 2018.

The $25.6 million remeasurement charge in the year ended December 31, 2018 reflects changes in the fair value of our common stock warrant liability and also a charge for warrants exercised during the period. In the year ended December 31, 2018, we recorded a revaluation charge of $7.3 million on the 0.4 million common stock warrants outstanding at December 31, 2018, which had an average fair value of $24.14 compared to $6.49 at December 31, 2017. In the year ended December 31, 2018, approximately 1.7 million warrants with an average exercise price of $2.86 per share and a December 31, 2017 fair value of $5.70 per share were exercised. The average market price of our common stock on the days of exercise was $19.54 per share, resulting in a charge of $18.3 million.

In the year ended December 31, 2017, the $29.6 million charge consisted of changes in fair value of common stock warrant liability expenses of $16.9 million and changes in fair value of the JGB Debt embedded derivative liability of $12.7 million of expense.

The $16.9 million expense related to our common stock warrant liability was due to:

The JGB Debt included certain embedded derivatives that require bifurcation, including settlement and penalty provisions. The $12.7 million expense related to the JGB debt embedded derivative reflects the change in the fair value of the derivative liability from the JGB Debt issuance date of March 15, 2017 to December 31, 2017. We utilized the Monte Carlo simulation model to estimate the fair value of the embedded derivative liability for the measurement at issuance and subsequent remeasurement at December 31, 2017.

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The $12.7 million increase in the fair value of the derivative liability mainly reflects the increase in the price of our common stock from $2.15 on March 15, 2017 to $7.34 on December 31, 2017 and the increase in the derivative liability related to the conversion of the JGB Debt into shares of our common stock during the term of the debt.

As of January 1, 2018, we adopted the new accounting standard and reclassified the outstanding common stock warrants issued in connection with the JGB Debt to equity. The JGB Warrants were not remeasured through earnings after January 1, 2018. This common stock warrant issued in connection with the JGB Debt were exercised in August 2018.  Warrants issued in connection with the Private Placement Warrants continue to be classified as liability and will be remeasured at the end of each reporting period until expired or exercised. Changes in the common stock fair value, estimated volatility and expected contractual term will significantly impact the fair value of the warrant liability.

Income Tax Benefit

For the year ended December 31, 2018, we recorded an income tax benefit of $1.4 million on a loss before income taxes of $48.2 million.  For the year ended December 31, 2017, we recorded an income tax benefit of $1.7 million on a loss before income taxes of $57.3 million. For both the 2018 and 2017 years, the income tax benefit is a result of the tax impact of the losses related to our foreign operations. The effective tax rate for the year ended December 31, 2018 defers from the federal statutory tax rate. This is a result of the full valuation allowance against U.S. deferred tax assets due to the lack of future source of taxable income and tax benefit as a result of losses in our foreign operations in the current year.

Comparison of the Years Ended December 31, 2017 and 2016

(In thousands)

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Testing Services Revenue

Testing services revenue increased by $3.4 million, or 12%, in 2017 compared to the same period in 2016 mainly due to the increase in AlloMap test volume representing $1.8 million, as well as increased AlloMap cash collections of $1.1 million.  AlloMap tests results delivered increased by 1,164, or 8%, in 2017 compared to 2016.

AlloSure was launched in October 2017 and contributed $0.5 million of testing services revenue.

Product Revenue

Product revenue increased by $3.9 million, or 37%, in 2017, compared to 2016.  The increase in product revenue mainly reflects product revenue not being comparatively included in the year ended December 31, 2016, as the Allenex acquisition occurred on April 14, 2016.

License and Other Revenue

License and other revenue increased by $0.3 million in 2017, compared to 2016, reflecting additional royalty payments received under our services agreement with CardioDx, Inc.

Cost of Testing Services

Cost of testing services increased by approximately $1.5 million, or 13%, in 2017 compared to 2016 primarily due to higher headcount related expenses of $1.1 million and laboratory material costs of $0.6 million. These increases were partially offset by a decrease in royalty payments to Roche of $0.2 million, as from September 30, 2017, no further royalties were due.

Cost of Product

Cost of product decreased $1.2 million or 12%, in 2017 compared to 2016. The decrease primarily relates to a net $3.6 million decrease in the charge recorded for the amortization of acquisition-related mark-up in the value of inventory. In 2016, a charge of $4.0 million was recorded related to inventory purchased in the Allenex acquisition. In 2017, a charge of $0.4 million was recorded related to the inventory purchased in the Conexio asset acquisition.

This decrease was partially offset by the effect of the cost of product not being comparatively included. The cost of product related to the Allenex and Conexio acquisitions are not comparatively included because the Allenex acquisition occurred on April 14, 2016 and the Conexio acquisition occurred on January 20, 2017.

Research and Development

Research and development expenses increased less than $0.1 million, or 1%, in 2017 compared to 2016. This increase is primarily due to a $1.0 million increase for product related development costs, which are not comparatively included in the twelve months ended December 31, 2016, as the Allenex acquisition occurred on April 14, 2016, partially offset by a decrease of $0.9 million of AlloSure development expenditures.

Sales and Marketing

Sales and marketing expenses increased by approximately $1.6 million, or 15%, in 2017 compared to 2016. The increase primarily reflects an increase of $0.9 million in the product sales and marketing payroll related expenses, due mainly to product related results not being comparatively included in the twelve months ended December 31, 2016. We incurred an additional $0.6 million related to headcount increases for customer service and sales operations personnel.

General and Administrative

General and administrative expenses decreased by approximately $1.8 million, or 9%, in 2017 compared to 2016.  The decrease primarily reflects a reduction in audit, tax and other professional and consulting fees incurred in 2016, primarily in connection with our acquisition of Allenex.

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Goodwill impairment

On January 1, 2017, we adopted ASU 2017-04, which eliminated the Step 2 requirement of the goodwill impairment test. Instead, the goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. In the three months ended March 31, 2017, we determined that the decrease in our market capitalization constituted an indicator of impairment and therefore a goodwill impairment test was completed as of March 31, 2017. The goodwill impairment test determined that the fair value of the former Pre-Transplant reporting unit was $3.5 million, which was lower than its carrying value. Accordingly, we recorded a goodwill impairment charge of $2.0 million for the three months ended March 31, 2017, which represented the remaining goodwill balance in the former Pre-Transplant reporting unit. No additional goodwill impairment was recorded in the year ended December 31, 2017. During the year ended December 31, 2016, we recorded goodwill impairment charges related to our former Pre-Transplant reporting unit of $13.0 million. The impairment test performed in December 2016 indicated a reduction in our forecasted revenue and operating results for the former Pre-transplant reporting unit. This was the primary cause of the reduction in fair value of the former Pre-Transplant reporting unit, which triggered the impairment charge recorded in 2016.

Change in Fair Value of Contingent Consideration

We revalued the contingent consideration liability for the years ended December 31, 2017 and 2016 and recognized a non-cash loss of $1.2 million and a non-cash gain of $0.5 million, respectively, as a result of management’s estimate of the probability meeting the milestone under our business combination agreement with ImmuMetrix, Inc. increasing to 100% at December 31, 2017, and our common stock price increasing by $4.67 and decreasing by $3.70 for the years ended December 31, 2017 and 2016, respectively.

Interest Expense, Net

Interest expense increased by $4.0 million for the year ended December 31, 2017 compared to the same period in 2016. The increase primarily consists of:

Debt Extinguishment Expenses

In the year ended December 31, 2017, debt extinguishment expenses of $0.5 million consisted of a $0.3 million loss on a $1.2 million conversion of JGB debt and $0.2 million of debt extinguishment fees on East West Bank debt. In the year ended December 31, 2016 no debt extinguishment expenses were recorded.

Other Expense, Net

Other expense decreased by $0.9 million in the year ended December 31, 2017, compared to the same period in 2016. In the year ended December 31, 2017, the other expense charge of $1.0 million consisted mainly of a foreign exchange loss of $0.6 million, $0.2 million for franchise taxes and $0.2 million in JGB Debt issuance costs. In the year ended December 31, 2016, the other expense charge of $1.9 million consisted mainly of a $2.1 million charge in 2016 to expense financing costs associated with a proposed six-month bridge loan that did not materialize.

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Change in Estimated Fair Value of Common Stock Warrant and Derivative Liabilities

The change in the estimated fair value of common stock warrant and derivative liabilities was due to a $29.6 million expense in 2017 compared to a $0.3 million expense in 2016.

For the twelve months ended December 31, 2017, the $29.6 million charge comprised common stock warrant liability expenses of $16.9 million and $12.7 million of expense related to the JGB Debt embedded derivative liability.  

The $16.9 million expense related to our common stock warrant liability was due to:

The JGB Debt includes certain embedded derivatives that require bifurcation, including settlement and penalty provisions.  The $12.7 million expense related to the JGB Debt embedded derivative reflects the change in the fair value of the derivative liability from the JGB Debt issuance date of March 15, 2017 to December 31, 2017.  We utilized the Monte Carlo simulation model to estimate the fair value of the embedded derivative liability for the measurement at issuance and subsequent remeasurement at December 31, 2017.  

The $12.7 million increase in the fair value of the derivative liability mainly reflects the increase in the price of our common stock from $2.15 on March 15, 2017 to $7.34 on December 31, 2017 and the increase in the derivative liability related to the conversion of the JGB Debt into shares of our common stock during the term of the debt.

Income Tax Benefit

For the year ended December 31, 2017, we recorded an income tax benefit of $1.7 million on a loss before income taxes of $57.3 million. The effective tax rate for the twelve months ended December 31, 2017 differs from the federal statutory tax rate as a result of the income tax expense and benefit related to the warrant revaluation expense and remeasurement of the deferred tax asset, partially offset by valuation allowance.

Liquidity and Capital Resources

We have incurred significant losses and negative cash flows from operations since our inception and had an accumulated deficit of $311.8 million at December 31, 2018. As of December 31, 2018, we had cash and cash equivalents of $64.6 million, and no debt outstanding.

JGB Debt

On March 1, 2018, we notified JGB of our intent to prepay on April 13, 2018, in full the outstanding principal and interest under the JGB Debt. During the three months ended, March 31, 2018, JGB converted all outstanding $26.7 million of principal and accrued interest of the JGB Debt into an aggregate of 6,161,331 shares of our common stock.  Restricted cash of $9.4 million was released from any restrictions after the conversion and included in our cash and cash equivalent balance as of March 31, 2018.

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Perceptive Credit Agreement

On April 17, 2018, we entered into the Perceptive Credit Agreement for a term loan of $15.0 million and repaid the outstanding indebtedness under the Allenex Notes, the Danske Bank Term Loan and the Danske Credit Facility.  On November 20, 2018, we paid off all obligations owing under, and terminated, the Perceptive Credit Agreement.

Allenex Notes, Danske Bank Term Loan and Danske Credit Facility

All outstanding amounts under the Allenex Notes of $4.4 million and Danske Bank Term Loan and Danske Credit Facility of $6.7 million were repaid on April 17, 2018.

Going Concern

As of December 31, 2018, we had cash and cash equivalents of $64.6 million.  We may require future additional financing to fund working capital and pay our obligations as they come due. Additional financing might include a combination of equity security offerings, debt arrangements or collaborations. However, there can be no assurance that we will be successful in acquiring additional funding at levels sufficient to fund our operations or on terms favorable to us.

We believe that our existing cash balance and expected revenue along with the net proceeds from any future equity financing available under our effective Form S-3 filed with SEC in August 2018, will be sufficient to meet our anticipated cash requirements for a period of at least 12 months from the issuance date of our consolidated financial statements.

The following table summarizes our cash flows for the years ended December 31, 2018, 2017 and 2016:

Cash Flows from Operating Activities

Net cash used in operating activities consists of our net loss, adjusted for certain non-cash items in the consolidated statements of operations and changes in operating assets and liabilities.

Net cash used in operating activities for the year ended December 31, 2018 was $4.0 million. Our net loss of $46.8 million was our primary use of cash in operating activities and included the following noncash items: $23.0 million loss on the change in fair value of warrants and derivative liabilities, $7.1 million stock-based compensation expense, $4.2 million of depreciation and amortization expense, $5.8 million loss on debt extinguishment expenses, $2.2 million amortization expense related to the JGB Debt discount, $1.2 million loss related to the revaluation of the contingent consideration, and $0.2 million on amortization of inventory fair market value adjustment. Net operating assets and liabilities decreased by $0.9 million.

Net cash used in operating activities for the year ended December 31, 2017 was $14.3 million. Our net loss of $55.5 million was our primary use of cash in operating activities and included a number of noncash items. Our noncash items included $29.6 million loss on the revaluation of warrants and derivative liabilities to estimated fair value, $3.8 million of depreciation and amortization, $3.5 million amortization of debt discount and noncash interest

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expense, $2.0 million of goodwill impairment, and $1.2 million loss related to the revaluation of the contingent consideration. Net operating assets and liabilities decreased by $1.1 million.

Net cash used in operating activities for the year ended December 31, 2016 was $16.5 million. Our net loss of $39.8 million was our primary use of cash in operating activities. Our net loss also included a number of noncash items including $13.0 million of goodwill impairment related to our purchase of Allenex, $4.2 million of amortization of inventory fair market value adjustment, $2.9 million of depreciation and amortization, $2.0 million of stock based compensation expense, and $0.5 million on a revaluation gain on a contingent consideration liability related to our acquisition of IMX in June 2014.

Cash Flows from Investing Activities

For the year ended December 31, 2018, net cash used in investing activities was $7.9 million and consisted of $5.2 million related to the acquisition of intangible assets per the Illumina License Agreement, $2.0 million for purchases of property and equipment and $0.7 million for the acquisition of the Allenex minority interest.

For the year ended December 31, 2017, net cash used in investing activities was $6.1 million, which was primarily due to the $5.4 million repayment of the deferred purchase obligation related to the Allenex acquisition and $0.5 million related to the acquisition of the assets of Conexio.

For the year ended December 31, 2016, net cash used in investing activities was $21.1 million, which was mainly the cash paid to acquire Allenex of $20.6 million, net of cash acquired of $0.6 million.

Cash Flows from Financing Activities

Net cash provided by financing activities for the year ended December 31, 2018 was $50.3 million and primarily related to $52.9 million net proceeds from the 2018 Public Offering, $14.3 million net proceeds from the Perceptive Credit Agreement, cash proceeds of $11.0 million from the exercise of warrants, $1.5 million cash proceeds from the exercise of stock options, and $0.3 million proceeds from issuance of common stock under employee stock purchase plan. Cash received was partially offset by $28.1 million of principal payments of the promissory notes issued to FastPartner AB and Mohammed Al Amoudi, Danske Bank Term Loan, the SSP Primers Loan, and the Perceptive Credit Agreement, $0.7 million of taxes paid related to the net share settlement of restricted stock units, $0.7 million repayment of the Danske Credit Facility, and $0.2 million of acquisition of Conexio.

Net cash provided by financing activities for the year ended December 31, 2017 was $29.4 million, which primarily reflected the proceeds from the 2017 Public Offering of $18.3 million, the JGB Debt proceeds of $24.0 million, $1.0 million related to the exercise of warrants and $0.3 million of proceeds from exercise of stock options. These amounts were offset by $12.8 million of East West Bank Debt extinguishments, $1.5 million principal payments on Danske debt, and $0.1 million of capital lease obligations.

Net cash provided by financing activities for the year ended December 31, 2016 of $24.9 million consisted primarily of $20.6 million from the issuance of equity securities in private financing transactions, $7.9 million in proceeds received from the Public Offering an underwritten public offering completed on September 26, 2016, net of issuance costs, and $0.3 million from the issuance of common stock under the employee stock purchase plan and the exercise of stock options, partly offset by $3.9 million of principal payments on debt and capital lease obligations.

Contractual Obligations

We are a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act, and are not required to provide the information required under this item.

Off-Balance Sheet Arrangements

As of December 31, 2018, we had no off-balance sheet arrangements as defined under Regulation S-K 303(a)(4) of the Exchange Act, and the instructions thereto.

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JOBS Act Accounting Election

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Foreign Operations

The accompanying consolidated balance sheets contain certain recorded assets in foreign countries, namely Stockholm, Sweden, Vienna, Austria and Fremantle, Australia.  Although these countries are considered economically stable and we have experienced no notable burden from foreign exchange transactions, export duties or government regulations, unanticipated events in foreign countries could have a material adverse effect on our operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We are exposed to market risks in the ordinary course of our business.  We had cash and cash equivalents of $64.6 million and $16.9 million at December 31, 2018 and December 31, 2017, respectively, which consisted of bank deposits and money market funds.  Additionally, we had no outstanding debt and $34.1 million as of December 31, 2018 and December 31, 2017, respectively.  Such variable interest-bearing instruments carry a degree of risk.  However, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates.  A hypothetical 50 basis point increase or decrease in interest rates during any of the periods presented would have an approximate impact of less than $0.3 million on our consolidated financial statements.

Foreign Currency Exchange Risk

We have operations in Sweden, Austria, Australia and sell to other countries throughout the world.  As a result, we are subject to significant foreign currency risks, including transacting in foreign currencies, investment in a foreign entity, as well as assets and debts denominated in foreign currencies.  Our testing services revenue is primarily denominated in U.S. dollars.  Our product revenue is denominated primarily in U.S. dollars and the Euro.  Consequently, our revenue denominated in foreign currency is subject to foreign currency exchange risk.  A portion of our operating expenses are incurred outside of the U.S. and are denominated in Swedish Krona, the Euro, and the Australian dollar, which are also subject to fluctuations due to changes in foreign currency exchange rates.  An unfavorable 10% change in foreign currency exchange rates for our assets and liabilities denominated in foreign currencies at December 31, 2018, would have negatively impacted our financial results for the year ended December 31, 2018 by $0.3 million and our product revenue by $0.9 million.  Currently, we do not have any near-term plans to enter into a formal hedging program to mitigate the effects of foreign currency volatility.  We will continue to reassess our approach to managing our risk relating to fluctuations in foreign currency exchange rates.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CareDx, Inc.

Index to Consolidated Financial Statements